Dhananath Fernando

Limited government – Ideal State

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In this weekly column on The Sunday Morning Business titled “The Coordination Problem”, the scholars and fellows associated with Advocata attempt to explore issues around economics, public policy, the institutions that govern them and their impact on our lives and society.

Originally appeared on The Morning


Limited Government; Ideal State – Part IV

By Dhananath Fernando

This article completes Advocata’s four-piece series on “limited government”. Over the past three weeks, we have presented three arguments in favour of a limited government. We began the series by delving into the mounting costs associated with a government of this size. The article questioned the rationale behind expenditure on this scale, given that the services provided by the Government are characteristically inefficient. Erratic power cuts and railway strikes seen in the recent past are testament to this. From here, the series explored the question of how a government can best serve its citizens.

The main argument presented was that when the powers and responsibilities of the State are decentralised, voters are given a stronger voice and are better able to hold elected officials accountable. The result is that public finances are better managed and service delivery improves. The last topic tackled in this series was that of corruption, expanding on how the window of opportunity for corruption widens when a government grows in scope as well as physical size, without the necessary governance and accountability measures in place. All three articles concluded on the same point – the size and role of the Government needs to be re-visited.

At a fundamental level, a government exists to protect the life, liberty, and property of its citizens. This is the first and foremost responsibility of a government and it is vital that this is given priority. The danger of governments expanding into other sectors is that these foundational responsibilities are pushed to the sidelines. When a government provides subsidies, creates price ceilings, and gives ad hoc handouts, it loses incentive to focus on its priorities. Giving a subsidy has an immediate impact on its voters and a cycle of instant gratification begins. Parallel to election cycles, governments now have an easier, quicker method to win over voters. Ensuring the rule of law and enshrining the negative freedoms of a population does not have the shiny appeal of a handout – the positive, virtuous cycles these freedoms and protections create are strong, they can permeate institutions and change cultures of work. However, they can take years to come into effect and are difficult concepts to convey through the flashy advertisements of an election campaign.

Of course, this means that governments respond to the attractive incentive of a quick win and an extended term in office, and prioritises the handout over the fundamentals of freedom. As much as these freedoms can create virtuous cycles of growth and development, the neglect and deterioration of these freedoms can create dangerous cycles of corruption, misuse, and violence.

The best way to illustrate these dangerous cycles is through the justice system. Unfortunately, we witnessed first-hand the aftermath of the Easter attacks where virulent rhetoric against the Muslim community resulted in riots, with 500 Muslim-owned shops being attacked and set on fire. In the face of this outbreak of violence, the rule of law was flagrantly abused, and peace was not upheld.

Eammon Butler, in his book “Foundations of a Free Society”, expounds on this in some detail. According to him, the rules of justice are a cornerstone of any free society. While rules of justice would mean there are penalties for harming other people, in a free society, emphasis is also given to ensuring the role and power of a government is strictly limited. This will mean that the monopoly over violence a government has will not be used arbitrarily or in the self-interest of those who wield it. To quote: “The main problem of political organisation is not how to choose our leaders – that is easy – but how to restrain them.”

This seems reasonable and rational. No one wants an army-running rampant – you want to ensure the people with the guns and ammunition have clear rules on when and why they can use it. Most governments recognise this and have mechanisms such as constitutions and the separation of the executive, legislature, and judiciary to restrain those in positions of power. But the foundation of this is to ensure that citizens are all treated equally under the law – that all laws apply equally to all citizens and there is equal treatment and due process of justice. For freedom to have meaning, it has to apply equally to the whole population. When this does not take place and there is essentially a break down in the rule of law, the immediate impacts might seem inconsequential. It might mean that someone gets out on bail when maybe they shouldn’t. It might mean that tariffs are raised to protect politically important local business interests. Taken alone, these are singular events, which, while problematic, don’t cause much consternation. However, this is a slippery slope which often ends in widespread corruption in the best case, and a complete breakdown of law and order in other instances.

Once again, recent events illustrate that all citizens are not treated equally under the law, and that instances where law and order break down are increasing in frequency. The Wennappuwa Pradeshiya Sabha (PS) Chairman issuing a letter prohibiting Muslim traders from conducting business at the Dankotuwa Market is a case in point. It is of utmost importance that steps are taken to ensure the rule of law is maintained, and the Government prioritises its core functions putting the safety and freedom of all its citizens at the forefront.

Axe-ing local carpenters

Originally appeared in the Daily Ft and Daily Mirror

By Dhananath Fernando

On 6 June, for World Environment Day, the President stated that he will ban carpentry sheds, and will ban the import of machinery used to cut down trees. Since that statement, there has been considerable policy confusion. It is unclear whether the Gazette notification was amended to ban carpentry sheds and these saws, or whether given public outcry, the ban was not implemented (Update: the ban was approved).

The policy decision to ban carpentry shops will have a similar situation. The ripple impact across livelihoods, industries, and supply chains is difficult to quantify.

However, this is still a matter worth discussing. Even if the Gazette is not amended, a precedent has been set for people in positions of power to take misguided decisions, which could affect the livelihoods of thousands of people. In this instance, the intent of this decision is to address problems of deforestation - the question is, will it achieve this goal?

In Grade 8, we were taught the negative impacts of disturbing the equilibrium in a system or an ecosystem. That should be the first lesson for all leaders in Sri Lanka, before they even think of the word “policy”. To date, I recall the story of my Science teacher. In a forest where deer and lions coexisted, the then-ruler realised that deer were the prey for lions - a situation the king felt was unfair. As a result, the king made a royal decree that all lions in the forest should be killed, in order to protect the deer. For a few years, this appeared to be a wonderful decision. However, a few years later, the absence of a predator resulted in a sharp increase in the deer population. As a result, the food sources in the forest were not adequate to sustain this unprecedented boom in population, and the deer had to resort to eating the barks of trees. Overtime, the damage to tree barks affected the overall health of the forest, as trees began to wither and die. The increased scarcity of food meant that the deer population did not have enough sustenance to survive. In simple words, the good intention of protecting the deer population ended up in the collapse of an entire ecosystem. 

Undoubtedly, the policy decision to ban carpentry shops will have a similar situation. The ripple impact across livelihoods, industries, and supply chains is difficult to quantify. However, there are a few consequences we can predict. 

Carpentry Problem

Furniture prices are likely to increase 

The banning of carpentry sheds will reduce the furniture supply in the market, pushing prices of wooden furniture up. The hike in prices will mean that sales drop, pushing carpenters out of the industry. As the President has halted approvals for new carpentry shops, the industry is effectively condemned to an early death, with no ability for new players to enter, and no incentives for current players to expand in the industry. 

 Incentivising deforestation, bribery and corruption

With the prices of wooden furniture skyrocketing, the President has created a situation where any industrious, entrepreneurial minded individual would want to enter this industry. However, as permits for new carpentry shops have been halted, there is no legal path for people to enter the industry. The incentives are then for these people to enter the industry illegally, using bribery as their entry ticket. The consequences of illegal logging and unregistered chainsaws are much larger than those of allowing this industry to function within a regulatory system. The Government will not be able to monitor or regulate the levels of deforestation in the country, and we are likely to witness an increase in loss of forest cover. 

Lack of innovation and unemployment across sectors

These new restrictions placed on the carpentry industry provide no incentives for people to innovate within the industry. New, affordable and effective ideas which would aid environmental protection are unlikely to come about. Other countries have experimented with private forests, industrial timber cultivation and development of equipment to minimise wastage and enhances productivity. This will not be the case in Sri Lanka. The impact will not be limited to carpenters. No industry exists in a bubble, it is supported by a myriad of ancillary industries which will all be affected. Transportation, painting, polishing, varnishing, wood carving, cushioning, housing, construction are just a few examples of industries which will be affected by rising costs of furniture. 

Possible solutions 

At present the import tax on furniture is 88%, pricing imported furniture out of reach of the majority of the population. With no alternative, people turn to locally produced furniture. It is unlikely that the carpentry industry is the driving force behind all deforestation problems in the country - but even if it were - a more effective policy reform would be to lower these taxes. If imported furniture was more affordable, consumers would change their preferences and demand for locally produced furniture and the logging behind this industry would fall. 

The current tax of 88% on furniture imports is difficult to justify. If the Government is concerned about the environment, it should be able to put aside its protectionist agenda for a decrease in the rates of deforestation. That no steps have been taken in this direction indicates that their motives may not be as clear as we thought. 

Bringing down taxes on semi-products and finished furniture products is vital to improving consumer choice and competition in the furniture market. This would encourage new entrants to the industry, and the increase in competition would mean that there are more incentives for people to develop environmentally friendly business models. 

Excessive regulations in tourism – ‘So Sri Lankan’

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In this weekly column on The Sunday Morning Business titled “The Coordination Problem”, the scholars and fellows associated with Advocata attempt to explore issues around economics, public policy, the institutions that govern them and their impact on our lives and society.

Originally appeared on The Morning


By Dhananath Fernando

Tourism – a topic that politicians and bureaucrats never get tired of. Following Easter Sunday, the tourism industry is now on a different trajectory. Security concerns have affected over 170,000 people directly employed and 220,000 people indirectly employed in an industry that contributes about 5% of GDP. The initial plan the Government had for 2020 was to increase tourism earnings to $ 7 billion from its current earning position of about $ 4.3 billion, and increase spending per visitor to $ 264 per day from the current position of $ 178 per day in 2018.

The approach taken by every successive government to increase numbers has been to make their mantra “promotion”. Just as the country follows the same traditions every new year, every successive government and the minister of tourism proposes a new campaign and a slogan for the Sri Lankan tourism industry. They produce scenic showreels and graphics of this splendid island to showcase at many travel exhibitions and to run promotions online as well as offline. We were the “Wonder of Asia”, then converted to the “Little Miracle” for a short time, and to the “Land Like no other”. And now we are “So Sri Lanka”.

While the slogans and promotion campaigns are of paramount importance, governments have failed to provide sufficient focus on the actual details that matter to the industry. This is reflected in the debt relief package offered in the aftermath of the Easter attacks. It might seem unrealistic to expect the Government to address concerns across such a large and diverse industry – when stakeholders range from high-investment airline operators to the destination point trishaw. However, a few simple business principles can be applied regardless of the stakeholder category.

  1. Minimum regulatory barriers to enter and exit the market

  2. Lower taxation so the prices will be affordable

  3. Minimum government intervention to allow greater efficiency at the ground level

Let’s go into detail with a few regulatory barriers mentioned on the website of the Tourism Development Authority for registrations of online/offline travel agents (destination management companies).

Travel agents and destination management companies are entities that coordinate an entire trip within Sri Lanka for tourists. They recommend the travel route, book the hotels and lodging on behalf of the tourist, and arrange everything from airport pick up to drop off. In short, they do an extensive coordination job. These travel agencies can be found on the internet and tourists can directly reach them over the web. There is also a business to business (B2B) model which is common in the industry. In the B2B model, the respective agent from another country approaches the local travel agents and the local travel agent acts as an agent of the particular company, and this works vice versa.

The profile of tourists shows that about 2.3 million tourists only spend an average of $ 163 per day over 10.8 days. The industry needs to be accessible for business newcomers to enter the travel market and create new value propositions to attract more tourists to Sri Lanka, especially at a time where the entire industry is shaken by the Easter attacks.

In the category of registering as a travel agent of Sri Lanka Tourism Development Authority (SLTDA), there are certain requirements which have to be met. Prospective businesses must show a 1.2 million working capital for a sole proprietorship and a one million working capital for a limited liability. Additionally, a bank guarantee of 10% of the working capital is required. Furthermore, SLTDA wants the new travel agent to have 250 square feet of furnished office space with a reception, telephone line, fax line, and a computer reservation system.

They have further made it mandatory to employ a minimum of three professionally qualified or experienced staff to work on transport, accommodation, currency, outcome regulation, reservation of airline tickets, and general information on travel and tourism-related services.

I am sure all these guidelines must have drafted with good intentions, but this has made it almost impossible for a new entrant to enter the market as a travel agent. To fulfil all the guidelines to get a license, you need more than Rs. 3-4 million, which makes it very difficult for a small and micro entrepreneur to enter the industry. In reality, a small operation as a travel agent would require one laptop with internet an individual with excellent coordination and communication skills. It would require a maximum of two to run a small-scale operation. A reception is not required as your clients are visiting scenic destinations and staying in hotels – they will not be visiting your office.

Even if a company wanted to impress their clients with attractive office space, there are many co-working spaces in Colombo where you can hire a desk space and a board room for a few thousand rupees on an hourly basis. While other industries, most notably tech recognising the benefits of a co-working space for start-ups, SLTDA still wants telephone and fax lines for an industry where most clients communicate on email and database call apps.

The guidelines provided for recruitment are a clear-cut case of how government agencies create bottlenecks affecting the ease of doing business. An entrepreneurial individual starting small will never take a risk of having three professionals on the payroll during the start-up period. They will instead hire a semi-skilled person who has the capacity to learn on the go. A travel operation simply does not require a professional graduate to run a small-scale business.

The Government initiated “Enterprise Sri Lanka Loan Scheme – Erambuma” provides a maximum of Rs. 1.5 million for a young graduate with an innovative business idea. While this is commendable, the regulations brought in by SLTDA will make it virtually impossible for a young graduate to set up a travel agency, even with the loan.

If the Government is serious about getting tourism on the track, it is of paramount importance that they reduce entry barriers for new entrepreneurs. If not, the plan of creating a tourism industry worth Rs. 7 billion will remain a castle in the air.

While regulation is important, especially to maintain standards and ensure quality, it is also important to distinguish between regulations that will help the industry grow and those that will stifle it. SLTDA regulates more than 25 such industries from hotels to scuba diving, and bringing all these regulations to light would fit a decent-sized book. It is necessary that SLTDA revisits its guidelines, keeping in mind how these guidelines affect both established players as well as new entrants who would really make a difference.

It is said “how you do small things will determine how you do big things”. While tourism authorities run promotions on the “So Sri Lanka” slogan, it would be useful for them to keep this phrase in mind too, before imposing regulations which restrict entry into the market.

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.