Sri Lankan Economy

Liberalising shipping agencies the first step to transform Colombo into a maritime hub

The article was published on - FTDaily MirrorCeylon TodayThe IslandDaily News

 

Last week’s budget contained important proposals around the liberalization of the shipping sector.

The port played a significant role in the development of  maritimes hubs such as Singapore, helping the country become a first world economy in a generation. With the right reforms, Sri Lanka’s ports could do the same.

Singapore’s domestic market is small-but its trade volumes massive: trade value is 3.5 times its GDP. Transshipments make up 85% of Singapore’s port’s volumes. Sri Lanka has 750 local shipping, freight forwarding and clearing agents but Singapore open market has over 5000.

The availability of frequent and reliable connections via sea and air (thanks to liberalisation) encourages companies across the logistics chain to operate from Singapore. High-frequency connections sometimes allow goods to reach their destination faster via Singapore than they would through direct shipments.

A foreigner-friendly regulatory environment has attracted investors to Singapore.  Around 20 of the world’s top 25 logistics companies have based their global or regional operations in Singapore. The presence of these big firms drives local companies to emulate international standards

The Colombo port starts with a number of advantages; well situated on the trade routes, it has a deep enough draught to accommodate post-panamex ships.

With a limited internal market Sri Lanka, like Singapore, cannot depend on traffic from its hinterland to develop its port. It must depend on transshipment traffic. Colombo already handles a significant amount of transshipment – 75% of volume; but mostly to India. The expansion of Indian ports poses a threat to this business, but to truly become a hub Colombo needs to look beyond our largest neighbor.

Transshipment is a service that does not add any value to cargo. To grow this service lower business costs and productivity are critical. Fast turnaround times and competitive rates are needed but Sri Lanka’s restrictive ownership rules and fixed fee structures result in higher costs.

Unlike other major ports where cargo handling rates are determined by market conditions, Sri Lanka’s are set by the Central Bank which decides on agency and transshipment tariffs to local agents. The current fee structure is complicated, encourages malpractice, is determined arbitrarily and adversely affects port and logistics industry competitiveness.

To shipping lines working with very thin margins this fixed fee structure represents a significant additional cost. This limits transshipment volumes to the essential-those that flow naturally due to location. Shipping lines have little incentive to route cargo from further afield.

The budget proposes to lift restrictions on foreign ownership of shipping agencies and the creation of a port regulator. This is the first step towards attracting the interest of  large global shipping lines.

Sri Lanka will not  become a logistics hub without significant participation of global players. Substantial investments and presence of global firms active on ground is essential toward making the hub ambitions a reality.  

With the right reforms in place,  Sri Lanka could look to attract attract Maersk or another leading shipper to establish its South Asia hub in Colombo. That would go well beyond its limited activity with its present JV arrangement with a local agent.  Sri Lanka can use this anchor investment, to  attract other leading shippers to do the same, thereby creating critical mass.  This would result in a larger industry, more jobs and more opportunities for the industry as a whole.  

This would make Sri Lanka fertile ground for the top freight forwarders.  It might persuade DHL or others to look at Sri lanka sa a regional hub and  large e-commerce companies such as Amazon  to use Colombo for warehousing.

This is why the liberalization is needed.  To develop, the logistics sector should be open to foreign participation and restrictions (eg Sri Lanka Ports Authority monopoly on destuffing local loose cargo), regulations on terminal handling charges etc. should be removed. Foreigners should be permitted to invest in freight forwarding and the minimum investment thresholds and export revenue requirements imposed to be eligible to invest in declared free ports should be eliminated.

Warehousing space available within the port is limited and outdated. To support the growth of the logistics business, private investment should be permitted within the port; to build and operate new, upgraded warehouses. Alternatively, there should be zoning of a warehousing district outside the port but in close proximity to it (like Singapore).

Other investments include creating logistic networks between producer and consumer areas, markets and transport nodes that connect to the Colombo port, industrial zones and Inland Container Depots (ICD) that speed port access and support a modern logistics corridor.

The presence of global third party logistics firms in Sri Lanka will enhance the confidence of multinational manufacturers who will be more willing to use Colombo as a destination for value added logistics functions (e.g. packaging, labeling, quality checking, simple assembly) etc.

These firms will bring new technology, new knowledge about logistics and supply chain management and are experienced in managing highly sophisticated and complex supply chains for their clients. It is the trust the global firms have in their logistics companies that make them outsource key logistics and supply chain functions and their presence firms will be a huge value add to the location advantage of Sri Lanka.

These firms will also help market Sri Lanka as a destination for logistics- which is needed to get business. This is far easier for such firms with their global presence and networks, than for local businesses.

This would form the core of a maritime-cum-logistics hub as these anchor investments create an ecosystem of supporting services -- financial, legal and other professional services. A maritime-cum-logistics hub would be a boon to competitive local companies with relevant service-support skills, and allow some of the bigger competitive companies to go global.

The Colombo International Financial Centre, a financial hub between Dubai and Singapore, is underway within the Port City. Along with the proposed National Logistics Policy for Shipping and Air Transportation, and the Telecommunication Connectivity Policy it will establish Sri Lanka as the hub of the Indian Ocean.

Production and service standards would improve massively from their present woeful state, with more transparency and less corruption.

This aligns with the Port City, linking up the port and airport, a hub around the airport as part of bigger Vision 2025 plans and would be the beginning of Sri Lanka's insertion into global value chains beyond garments. The big prizes are in services, not manufacturing, especially with the "servicification" of Global Value Chain.

The lower cargo handling costs and greater efficiency will create spillover benefits to local exporters who will increase their competitiveness, further driving volumes.

Opening up the agency business does not necessarily mean the end of the local agents; Singapore has over 5000 agents and sub agents working for ship owners/operators in numerous support businesses.

The shipping and logistics business is continuously evolving and new competition is emerging. An ADB working paper opined that “Slow implementation of the Colombo outer harbor development plan has already caused significant damage to Colombo as a transshipment hub. This damage may be repaired but it is unlikely. Further threats to its current role exist, not least the further development of ports in India”

Sri Lanka has been lucky for a long time, because we still retain our advantage in terms of serving the Indian Sub-Continent cargo but it is naive to imagine that this will last. Sri Lanka is operating far below its potential, especially in terms of logistics. Therefore, it is important to remove all constraints which prevent us from reaching our potential.

The budget proposals are a good start but full reform package of port, shipping and warehousing services is needed. This presents much greater opportunities for existing players in the long term and they should seize the challenge. Unless reforms take place we may well find ourselves stagnating while traffic moves to competitors.

Cheap footwear imports benefit ordinary Sri Lankans

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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


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

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.

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.

 

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

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

Plans to impose a Rs 10,000 Minimum wage: Will it improve welfare?

By Ravi Ratnasabapathy 

The article originally appeared on Dailynews on 7 May 2015

It is reported that the Government intends to legislate a minimum monthly wage of Rs.10,000 with an increment of 25% to be imposed over the next year. An increment of Rs.1,500 is to be effective from May 1 2015, while the rest will be effected from May 1 2016.

The legislation is probably founded in good intent: improvement of the welfare of citizens. Improving the welfare of people should be one of the fundamental objectives of a Government and one that few, if any, would question.

In simple terms we may measure welfare as the standard of living or in economics, the amount of goods and services that a person can enjoy. To the average person it may appear obvious that there is a minimum that one needs to earn to pay for basic foodstuffs, rent, electricity and utility bills and other expenses to live as a human being.

The standard of living is dependent on two factors: the income of people and the cost of goods and services. If the cost of goods and services is low then people do not need a high income.

A price list from Ceylon Cold Stores dating from the 1950's or 1960's lists the price of an imported Australian chicken at Rs.3.10 per pound, haddock fillet from Scotland at Rs.3.00 per pound and ice cream at Rs.10.00 per gallon. The author recalls paying a rupee for bread and 15 cents for the bus fare to school. If costs had remained at those levels people could have lived comfortably on a few hundred rupees a month.

Therefore in striving to improve the welfare of people there are two approaches that may be taken: the increase of wages or the reduction in the cost of living. Moreover if the cost of living increases faster than wages, people will be worse off, even if wages keep rising.

Sri Lanka has a highly distorted tax structure with essential commodities and foodstuffs being taxed at high rates. The previous regime excelled at the art of taxation by stealth with “special commodity levies” being imposed on milk powder, dhal, canned fish, potatoes, onions, chillies and a host of other foodstuffs. Milk powder is taxed at Rs.135 per kg, dried fish at Rs. 102 per kg, butter at Rs.880 per kg, cooking oil at Rs.110 per litre.

This is quite apart from VAT and other levies that add a further 15%-16% to costs. The taxes form a significant part of the final price of the goods. The current regime has cut some of the taxes but there is much more that could be done.

The problem that the Government faces in cutting taxes is that they have no means of paying for the bloated public service. The Government spends 54% of the tax revenue just paying the salaries and pensions of public servants.

Due to high levels of debt, interest cost takes up a further 38% of tax revenue.There are also huge inefficiencies and waste in the public sector. Sri Lankan Airlines lost Rs.30 bn in 2013, the cost of which is passed on to people as higher taxes.

The cost of living can be reduced significantly, with consequent improvement in welfare of the people, if taxes were cut but in order to do so waste and inefficiency in the public sector must be reduced.

Returning to the minimum wage, in order to impose a minimum wage, there needs to be employment.

The Government can impose minimum wages but this will have little effect in improving welfare if people are unemployed. There is no point in absorbing the unemployed into public service, as the previous regime did on grand scale because paying for this means taxing-and impoverishing the population at large.

Therefore the first step in poverty reduction is to ensure that jobs are created in the private sector, the second step being to control the cost of living.

The problem is that if the minimum wage is set too high and economic activity that takes place at low wage levels may become unviable.

Low wage jobs generally employ unskilled labour; if jobs are lost it is the poor who will suffer. It is better to have a low-paying job and some income rather than no job and no income.

As liberal economist Paul A. Samuelson wrote in 1973, “What good does it do a black youth to know that an employer must pay him $2.00 per hour if the fact that he must be paid that amount is what keeps him from getting a job?

In 2003, South Africa imposed minimum wages in agriculture to provide protection for workers to a sector with lowest average wages in the country.

A study on the impact of this by Bhorat, Kanbur and Stanwix concluded that while farmworker wages rose by approximately 17% as a result of the minimum wage, employment fell significantly, by over 20% within the first year.

A study of the impact of minimum wages in Indonesia by Asep Suryahadi, Wenefrida Widyanti, Daniel Perwira and Sudarno Sumarto reached similar conclusions. Since the late 1980's minimum wages had become an important plank of Indonesian government policy. While minimum wages succeeded in increasing average wages employment declined.

According to the study, a 10% increase in minimum wages resulted in a more than one per cent reduction in employment for all categories of workers except white collar workers.

Given the evidence available, the Government's decision to impose a minimum wage must be viewed with caution. If the minimum wage is significantly above market rates it will cause a decline in employment. The current wage level of Rs.10,000 is fairly low and anecdotal evidence suggests that its impact on employment will be small but once such legislation is in place the question of increments comes up.

A politician looking for quick votes in an election year may promise a high increase to the minimum wage which may reduce employment in the long term, to the detriment of the poor.

This policy, taken together with the ill-conceived taxes imposed in the budget sends a negative signal to investors. Investment in new business is needed to create employment, so sending the right signals is important. Not only could this policy destroy existing employment it could also be a dis-incentive to the creation of employment in the future.

It is advisable that the Government reconsider this policy. 


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

Expanding Trade with India : Winning with Competition or Cowering under Protection?

By Anushka Wijesinha

The article originally appeared on the Daily Mirror on April 29, 2015

In preferential trade agreements, we often see the potential losers being the most vociferous and more organized, while the gainers are quieter and more fragmented. This has been a typical characteristic of the debates on the India-Sri Lanka Free Trade Agreement (ISFTA) and the proposed Comprehensive Economic Partnership Agreement (CEPA) as well. But Sri Lanka must be careful of letting one side be heard more – by the public as well as by policymakers – than the other. More eclectic and informed debate representing all sides is essential, which is why I look forward to moderating this afternoon’s National Chamber forum on ‘CEPA and Its Implications for the Sri Lankan Economy’ – the first by the private sector following Indian PM Modi’s visit and announcements by both him and the new Sri Lankan government that they would forge ahead with the deal.

Deeper Engagement

The proposed CEPA would expand the current ISFTA to cover services, investment, and economic cooperation. The agreement was to take in to account the massive asymmetry between the two countries (economic size, population, etc.), afford Sri Lanka a more than disproportionate advantage, and allow for partially or fully restricting sectors it didn’t wish to open up right away. Following aggressive lobbying by narrow nationalist business leaders with close political affiliations, there was an eruption of uninformed and exaggerated sentiments against promoting greater commerce with India over the past few years. These groups successfully scuttled efforts at completing the CEPA deal several times in the past. “CEPA” became such a taboo word that the India-Sri Lanka Joint Statement in January 2013 avoided using that terminology, and referred to a “special economic partnership framework” instead!

Problem with Protectionism

It is not surprising that protectionist trade lobbies have emerged so influential. Sri Lanka has been sliding backwards in its openness to the world. For around 10-15 years now, protectionism has been on the rise and there has been a creeping up of applied tariffs and para-tariffs. A tangle of para-tariffs has now effectively doubled nominal protection rates to over 20%. Simultaneously, successive Budgets have introduced a range of ad hoc, special protection and promotion schemes for various domestic industries and indigenous enterprise. While this is not an unprecedented industrial policy approach, it does serve to weaken competitiveness of Sri Lankan firms. I recall a conversation with a business school friend of mine who started a high value added spice export operation out of Sri Lanka some years back. He lamented about the severe protectionist behaviour from local spice industrialists even though the project had been given the green light by the necessary authorities. Economic theory and evidence amply proves that in the presence of protection and in the absence of competition, firms become more complacent, less innovative and dynamic, and less able to face international markets. Is this what has happened to Sri Lankan firms vehemently against expanding trade ties with India? Ill-prepared for competition, cushioned by industrial policy that afforded special comforts?

 Government Must Play Smarter Role

It is incumbent on the government to ensure that stakeholder concerns are heard and addressed; that as much transparency as possible is maintained (without of course compromising the country’s negotiation position), and information is shared more comprehensively and consistently so as to prevent groups with narrow vested interests being able to misinform an mislead. Most importantly, the government cannot let the agenda be highjacked and held hostage by narrow interests groups, like in the past. A bilateral trade or economic partnership agreement that Sri Lanka enters in to affects not just a handful of firms and their employees but hundreds of other firms, hundreds of thousands of employees, and millions of consumers in Sri Lanka. The government must provide a clear policy direction on its economic engagement with India, making a strong departure from the ambiguous statements of the past – i.e., calling for a ‘special economic partnership agreement’. Meanwhile, although I did acknowledge at the start that the gainers from freer trade are often fragmented, less organized and less vociferous, it’s time that changed. Consumer and producer groups that gain from freer trade must speak up.

Opportunity to Win Big or Cower Down

Whether its called a CEPA or any other variation of it, the fact remains clear – it is in Sri Lanka’s interests to deepen economic ties with India. An agreement must be forged that cleverly expands Sri Lanka’s economic interests – those of our firms and our consumers; not a narrow few of them, but the wider many. To those who claim that it threatens our national interest, we must remind them that expanding our trade interests for the benefit of the many is also a part of our national interest. Just the opportunity to tap in to India’s growing middle class alone, set to be over 250 million this year – 20 times our entire domestic market – can be transformative. There are Sri Lankan firms with quality products that can and must break in to India. There are service providers, including dynamic Sri Lankan start-ups like Trekurious – a provider of unique lifestyle experiences – that have already entered India and demonstrated early success. A bilateral agreement will ensure that the systems are set out, for companies like these to operate in a rules-based environment. And if it is that we feel Sri Lankan firms cannot face competition, and it is for that reason alone we should not go for deeper economic engagement, then I’m afraid we have bigger things to worry about than a four-letter word starting with C.


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