The State of State Enterprises in Sri Lanka

Limited government – Ideal State

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

Originally appeared on The Morning


Limited Government; Ideal State – Part IV

By Dhananath Fernando

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

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

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

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

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

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

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

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

Less spending, less corruption

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

Originally appeared on The Morning


Why should we have a limited government? – Part III

By Aneetha Warusavitarana

The World Bank quite simply defines corruption as the “abuse of public office for private gain”. Accordingly, public office can be abused when private agents actively offer or accept bribes, institute practices of patronage and nepotism, and engage in the theft of state assets or misuse public funds. In Sri Lanka, corruption has become institutionalised and can range from the traffic policeman who accepts a bribe to a high-ranking bureaucrat siphoning public money for personal expenses.

In 2018, Sri Lanka ranked 89th out of 180 countries in Transparency International’s Corruption Perception Index. As a country, we score 38 out of 100, with 100 representing a clean, corruption-free country. The magnitude of this problem is clear.

What’s the big deal about corruption?

Bribery

Is corruption really bad? You can’t deny that when your garbage is piling up, it’s easier to bribe the garbage collectors to take your garbage than visit your municipal council and file a complaint. Sometimes, it can just be easier to pay a bribe to the traffic police than go to court and settle a traffic violation, or to pay a little extra and get your driving license renewed faster. These are all very mundane, commonplace occurrences that have become normalised to the point one does not think of it as “corruption”. It’s just a small payment to make your life a little easier – a small payment to ensure an application is processed smoothly. So, if corruption can make things simpler, what’s the issue?

While corruption on this scale can appear to be insignificant, in reality, it is one component of a much larger, systemic problem which has far-reaching consequences. Corruption in government is institutional, and given the outsized role the Sri Lankan Government plays in markets and business, the impact is far-reaching. The difficulty in holding government officials accountable and the considerable discretion they can wield creates an environment in which corruption can flourish.

The far-reaching impacts of corruption

Large corruption scandals often focus on the amount of money that has been misused, placing emphasis on face value loss that is created by corruption. However, the impact of one act of bribery or corruption goes far beyond the initial monetary loss. Corruption raises the transaction costs of conducting business and creates uncertainty in the market. In an environment where corruption flourishes, a business will not win a contract based on merit and skill alone. Procurement-related issues (read: corruption) associated with the Kerawalapitiya Power Plant meant that it took three years to award the tender. This lowers profitability within firms and creates an overall environment of uncertainty which discourages foreign investment. The result is that the positive spillover effects from investments, like increased competition and technology transfers, will not take place. Corruption also reduces the attractiveness of entrepreneurship, resulting in higher prices and lower quality. The problem does not end there. The culture of corruption is one of impunity and complete disregard for the rule of law. When this culture permeates the government, it affects the independence and credibility of the legislature and the judiciary – the very institutions which should be ensuring that the rule of law is upheld.

State-Owned Enterprises and corruption

Sri Lanka’s state-owned enterprises are a prime example of institutionalised corruption. In Advocata’s flagship report, the State of State Enterprises in Sri Lanka – 2019, the problem of corruption is a key issue tackled. In this report, corruption is explained through the perverse incentives that exist in the Sri Lankan bureaucracy. In the case of state-owned enterprises, as the money invested in state-owned enterprises is not of the politicians, there are no incentives for politicians to work towards making these enterprises efficient or productive. However, given the deep-rooted culture of patronage that exists in Sri Lanka, there is a strong incentive for politicians to use state-owned enterprises for their own gain. The lack of oversight or accountability means politicians can hire almost indiscriminately, giving out jobs for political gain. The reports from the Committee on Public Enterprise (COPE) make this abundantly clear, highlighting the numerous instances where recruitment had taken place without the appropriate approval from the Department of Management Services.

This problem is exacerbated by weak systems of accountability and governance. While the COPE and the Committee on Public Accounts (COPA) do play a role in the governance of state-owned enterprises, they have access to limited resources and equipment and are in need of specialised skills such as legal aid.

What is the solution?

If corruption is the abuse of public office for private gain, then in order to stop corruption, we should focus our attention on how and where this abuse happens. When the government moves outside its core mandate to protect life, liberty, and property, it grows in size and in scope, making the government difficult to monitor and hold accountable. Additionally, as a government grows in size, so does its spending. Changing a culture of corruption will take a great deal of political will and leadership, as well as buy-in from the bureaucracy. While accountability and transparency play an important role in countering corruption, the effects of this are seen in the long term. In the short term, focus should be on limiting the scope of the government and thereby drastically reducing government spending. A 10% cut of Rs. 3 million is significantly lower than a 10% cut of Rs. 300 million; reducing government spending is the fastest way to reduce corruption in quantitative terms. A reduction in government spending will also make transparency within the government easier to enforce, helping create a culture of accountability.

If we are to seriously tackle the problem of corruption in government, the role and scope of the government needs to be revisited and limited.

Decentralisation: Taking governance to the ground level

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

Originally appeared on The Morning


Why should we have a limited government? – Part II

By Aneetha Warusavitarana

When speaking of a limited government, the first thing that comes to mind is the fact that governments tend to be so expansive. A plethora of ministries and an innumerable amount of departments and agencies spring to mind. However, it is important to keep in mind that when speaking of a limited government, the rationale goes far beyond arguing for fewer ministries and reducing the duplication of work and responsibilities within the government system. A limited government is one that is limited in scope – it identifies its key functions and expends all resources to achieve them. When speaking of the role of the government, its primary functions can be described as the protection of life, liberty, and property. When a government’s main role expands beyond this, there is a strong likelihood that the government will prove to be ineffective and even harmful.

How can a limited government run a country?

It’s all well and good to say that the role of the State should be limited to the protection of life, liberty, and property, but governments also provide a myriad of public goods. Doing all this requires resources, people, and departments. Given that this requires a significant amount of administration, how do you ensure the government does this effectively, while staying within its key mandate and with minimal corruption or abuse of power?

Can decentralisation be the answer?

Decentralisation

Why should Sri Lanka move away from a centralised system of governance and increase the levels of decentralisation in the country? While there are some very theoretical explanations for decentralisation (which are important in their own right), we will use a simpler approach. In a population of approximately 21 million diverse people with different interests, preferences, and disposable incomes, how do markets allocate resources efficiently? Any A/L economics student will reply with the brief answer of the “invisible hand”. In reality, of course, there is no puppet master moving fruits and vegetables from one place to another. Each individual business acts in their own self-interest, resulting in a more efficient allocation of resources. Prices signal to these businesses – and the profits or losses these businesses make guide decisions to produce or sell – and thus, without the convening of committees or the presentation of any findings, an entire country is provided with goods and services it requires. William Easterly sums up this phenomenon as such: “The wonder of markets is that they reconcile the choices of myriad individuals”.

Price signalling works well in allocating resources because at any given point of time, it is impossible for one bureaucrat, or even a host of committees of bureaucrats, to have all the information necessary to dictate the production and distribution of a single good in an economy, much less all goods in an economy. This is because information and knowledge are localised, time sensitive, and tacit. In other words, information and knowledge cannot be transferred effectively in their entirety or in time. The fall of the Soviet Union is a testament to this.

What do markets have to do with decentralisation?

The same principle applies. The decision-making in a market economy is never centralised. While decentralisation will, of course, function differently – the spontaneous order created by price signalling in markets will not be making administrative decisions – the principle that centralised decisions are not effective stands. The reason behind this is that the information problems, which plague centralised decision-making of economics, also plague centralised decision-making for administration and governance. As much as a bureaucrat will find it impossible to distribute exactly the number of potatoes required to each province of this country, it is equally difficult for a bureaucrat to be located in a central government and to take decisions on local infrastructure. Any decision taken at a central level will not be ideal. There will always be information and local contexts that a bureaucrat is not privy to, and as a result, the decision will not be as effective.

Decentralisation brings governance and administration down to the ground level – it means decisions are taken by local government authorities who are best placed to make that decision. They are aware of local contexts and have been elected into office by the people in the locality, which would mean they have an understanding of what is needed. Of course, where the rule of law is weak, decentralisation can mean that local government authorities succumb to crony capitalism, as a system it is not without its faults. However, when comparing central governance and decentralised governance, in the case of decentralisation, there is greater opportunity for electorates to hold their representatives accountable, make their demands heard, and push for the reform that they want. In other words, it puts more power with the people and makes elected individuals more accountable to their voters – an admirable objective not only in principle, but also because of its effectiveness.

The burden of unprecedented costs

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

Originally appeared on The Morning


Why should we have a limited government? – Part I

By Dilshani Ranawaka

“The government that governs best, governs least” – Thomas Jefferson

A state has three core tasks within a society: Protecting the life, liberty, and property of the people. As societies evolved, these core tasks were overlooked when more emphasis was given to managing economies. Should the state intervene in economic affairs? Would that be more beneficial to the economy and society?

For the following four weeks, “The coordination problem” will discuss why large governments cause more harm than good when they engage in tasks beyond ensuring freedom and security of the citizens and the rule of law.

The series titled “Why should we have a limited government?” will justify why large governments are a bane to the economy through arguments on costs, problems of coordination, and corruption. The series will then conclude with a fourth piece on what an ideal state looks like.

It is intuitive that larger governments incur larger costs. This takes place through two avenues: recurrent expenditures and management expenditures. The present Government has lost count of the number of enterprises the State owns, as revealed by the Advocata Institute’s recently published report “The State of State Enterprises in Sri Lanka – 2019”.

As of 2017, 1,389,767 of the labour force in Sri Lanka are employed in the public service. This is around 14.5% of the labour force. The enormity of these numbers is clear when compared with developed countries. For instance, Canada, which has a population of 37.6 million, has a public sector of 262,696, according to the official Government of Canada website, making it clear that a government does not need to be expansive even in the instance of a large population.

To make things even worse, the Government introduces salary increments either at the onset of an election or during a new budget proposal, instead of having increments dependent on performance.

With the recently proposed increment of Rs. 10,000 for the public sector, the expenditure for wages adds up to Rs. 768 billion for the year. This is around 25% of the government’s expenditure, as per the Budget in 2019. This exceeds the amount allocated for public investment (Rs. 756 billion) for the year 2019, which is around 24% of the budgeted expenditure for this year.

These complicated numbers bring questions to mind: Is providing jobs a role of a government? What is the opportunity cost? What are the indirect consequences? What is the concealed political gain from this process?

A state’s role goes beyond providing job opportunities. Some of the crucial elements a state should look into are national defence and maintaining law and order. The Easter attacks and ensuing events highlighted that the Government should be focusing more on its core functions before moving beyond.

Furthermore, when looking retrospectively at political campaigns, politicians target the votes of government officers mainly through the introduction of wage increments. While increments are positive incentives for productivity, politicians use them for popularity. In such cases, two factors increase the costs for the government. Since larger governments require more state officers for administration purposes, the costs incurred just for administration purposes increase. When politicians promising higher increments become popular, the cost burden for the government piles up.

Every decision made in the economy has an opportunity cost. A state could allocate resources either for consumption or for investments. Investments generate direct income in the long run while consumption creates effective demand which indirectly generates income. Given this backdrop, it is important to answer why unregulated and irresponsible expenditure by a state is catastrophic.

Let us explain through a simple example. If a household spends on consumption which does not generate income, the household has to resort to loans. A similar argument can be transposed towards a state. If a state spends on consumption (in this case the cost for expansion of the government), they have to utilise other methods such as loans or taxes which are reflected back on the taxpayers of the country. These wage expenditures incurred by the government are utilised for consumption most of the time. Alternatively, if politicians stop promising salary increments and reduce the size of the government, these wages could be utilised for public investments – a critical requirement for economic growth and long-term income generation.

Cost Burden

Leaving vital services aside, what do state officers incur to the government? Losses or revenues? Would an additional state officer cover the cost of their wages and generate revenue through their productivity? Would it increase the efficiency of the department? These questions should be standard criteria before unnecessarily expanding particular state departments. The experience one has at most government institutions speaks for the inefficiency that plagues these institutions.

What is the underlying cause of incompetence of the State in Sri Lanka? If the government is supposed to facilitate services, why do they operate their entities in a manner they generate losses? Why do we constantly see power cuts through the Ceylon Electricity Board (CEB) if larger governments are meant to provide better services? Could we keep our trust on the State, given the way they function with our money?

Do larger governments function better? The evidence seems to indicate otherwise.

How many committees does it take to fix an airline?

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

Originally appeared on The Morning


By Dilshani Ranawaka

On 1 March, the International Monetary Fund (IMF) approved $ 164.1 million under the Extended Fund Facility after successfully completing the fifth review for the country. According to the IMF, restructuring and enhancing the governance of SriLankan Airlines and other state-owned enterprises (SOEs) and the implementation of price formula are key issues that should be addressed.

SriLankan Airlines has a new CCO and CFO as a result of the numerous numbers of commissions formed to assess and come up with a restructuring process. Presently, the losses alone had accumulated up to Rs. 40 billion in a time frame of 2016-2018.

The solution is pretty straightforward – find the root cause and then come up with recommendations. However, restructuring in the case of SriLankan Airlines appears to be a rather daunting process for the Government, with endless committees and subcommittees working on a strategy. The Government started off by appointing Cabinet members and state officials in the first commission. It took them three years to realise that it is crucial to appoint experts to look into this matter. Even after appointing four committees plus consulting the best in the aviation industry, Nyras, what they have achieved so far is the appointment of a new board and a new management along with the CCO and CFO. Given the climbing amount of debt from operating the airline and also knowing the intensity of the losses, why have they taken such a long time to plan a way out of this?

The first such committee was formed back in May 2017, focusing on privatising the airline. The council was headed by Prime Minister Ranil Wickremesinghe and consisted of officials from the Cabinet and other state officials. Following up on the process, it was reported that the Prime Minister was to take the decision on restructuring the airline in July 2017.

“By 31 July, we have to give an internal restructuring plan to the Prime Minister, basically looking at what we have to do internally with SriLankan – irrespective of whether we are getting a partner or not, we need to move forward,” a statement given by then Minister of Public Enterprise Development Kabir Hashim.

However, implementation did not materialise, and on 8 December 2017, the President appointed another special ministerial committee and a committee of officials to assist them to decide the fate of SriLankan Airlines with a deadline of two weeks, with a report due to be submitted on 20 December 2017. The actions regarding the airline were to be implemented on or before 31 July 2018. Why does the Government take such a long time – almost half a year – to implement these recommendations? The role of any government in an economy is to adjust market failures, not to cause more.

By 2018, Nyras, one of the leading aviation consultancy firms, was hired after the initial round of recommendations, and it presented a comprehensive report. However, the consultancy group has now filed a lawsuit against the Government because of delayed consultancy payments. While these measures were taken and international consultants were hired, SriLankan Airlines was still piling up losses at an exponential rate.

By 7 January 2019, the President formed yet another commission to conduct a comprehensive study – review the present vision and mission objectives, strategies, corporate plan, and action plan of the airline – and come up with recommendations for restructuring, which does not consist of any member of the previous committees formed by the President. Does this mean that the previous four committees appointed (two committees in 2017, one in 2018, and another in 2019) are redundant?

Exercising our rights as citizens, we need to push for fast reforms as this is a black hole sucking out tax-payer money. It has taken five committees, including consultancy from Nyras, to address various issues of SriLankan Airlines for the past three and a half years. With these five committees, what the Government has achieved so far is inducting the board of the airlines.

What we can take from this is:

  1. The commissions have submitted recommendations that wouldn’t work

    or

  2. The Government is incapable of implementing these recommendations

    or

  3. The Government is being willfully negligent by not taking action and implementing recommendations.

Given past experiences, these failures indicate a combination of the second and third conclusions.
SriLankan Airlines, which was then operated under Emirates – a renowned carrier of United Arab of Emirates, enjoyed a profit of Rs. 4.4 billion for the year 2008. The next 10 years, once the airline was taken over by the Government, suffered heavy losses due to the decline in performance and poor governance. The national airline had been climbing down in terms of performance as well as losses.

How many committees would it take for the Government to really execute any of these plans? When the good governance regime started their office in mid-2015, the losses of SriLankan Airlines were Rs. 16.4 billion. The losses of the airline had more than doubled up to a cumulative loss of Rs. 40 billion for the time period between 2016 and 2018. It took losses of Rs. 40 billion, and three years’ worth of planning to appoint two vital roles, the Chief Commercial Officer and the Chief Financial Officer, to the airline. How enormous should the losses be for the government to implement restructuring procedures? What would be at stake by then? This is indefinitely an answer Sri Lankans would not like to find out.

Keeping track of our state enterprises

Originally appeared on the Daily News

By Aneetha Warusavitarana

The Sri Lankan government is currently in a rather confused state of having lost track of the number of state enterprises it runs.

While the Ministry of Finance tracks the financials of 55 key SOEs, the government does not have an official number for the enterprises it runs. The Annual Report of the Ministry of Finance states that there are 400 and this is true to a certain extent. In the Advocata Institute’s 2019 report on the state of state enterprises, it has identified 424 principal SOEs, 84 subsidiary SOEs and 19 sub-subsidiary SOEs; bringing the total to a shocking 527 entities.

While it is bewildering that the government runs a minimum of 527 entities, the losses sustained by these enterprises are a greater cause for concern. When looking at the financials of the 55 strategic SOEs (which account for only 10.4% of the 527), the cumulative losses for the period of 2006 – 2017 amount to a massive Rs. 795 billion.

Reform promises

Apparently, the government has taken note of this. Reform has been promised by a variety of politicians at pivotal political moments. The election manifesto of President Maithripala Sirisena stated,

“I will implement a plan corresponding to Singapore’s Thamasek model to regularise the Management of State owned strategic institutions and sectors such as state banks, the harbour, energy, water supply, airports and transport.”

This is essentially a good starting point. Under the Singaporean Temasek model, one holding company is responsible for countries’ public enterprises. This is a model that has worked, with variations being adopted in other countries.

The Indonesian variation of the model has one holding company for each sector – given that Sri Lanka is a much smaller country it is possible that we could manage with one holding company.

The benefits of adopting this model lie in the accountability it creates. Having a holding company creates distance from the government and its SOEs, reducing chances for political intervention. It’s important to note that the Prime Minister has also expressed his support for this model, which meant the policy had buy-in from both sides of then unity government. While the Temasek model is a step in the right direction, if we want our SOEs to be efficient, privatisation is where the final solution lies.

On that note, the ‘privatisation of state-owned enterprises’ was mentioned early in the 2016 budget speech. The speech highlighted the loss-making nature of SOEs and the negative impact this it had on the budget. The solution mentioned was the use of ‘corrective measures’ to transform SOEs into commercially viable enterprises.

The methods recommended were selective, market-based pricing mechanisms for public utilities, rationalising of recruitment and exploring public-private-partnership opportunities.

The budget speech of 2017 also stated that steps would be taken to make SOEs viable business entities through cost reflective pricing structures and operational autonomy.

It went further, committing to the listing of non-strategic enterprises such as the Hyatt, Grand Oriental Hotel, Waters Edge, West Coast, Manthai Salt, Hambantota Salt and Hilton. The rationale was that the money raised could be used for debt repayment. Notably, both the budget speech of 2018 and 2019 were silent on the topic of SOE reform.

Working under the assumption that these promises were made in good faith, there is the question of why reform never materialises. It is possible that we have been trying to run before we can walk. While SOE losses have to stemmed, it may be better to have smaller, digestible phases of reform than a large reform agenda which will never move beyond a statement or speech.

Reform is vital, but should realistic

A key point highlighted in the recent IMF staff report was the losses sustained by state owned enterprises. Three main SOEs; the Ceylon Petroleum Corporation (CPC), the Ceylon Electricity Board (CEB) and SriLankan Airlines have recorded a combined loss of 1.3 per cent of GDP in 2018, compared to 0.5 per cent of GDP in 2017. The report also puts the financial obligations of non-financial SOEs at 11.8% of GDP.

Given rising losses and the urgent requirement for some level of action to be taken, it may be that the government should focus on smaller, more achievable reform that lies within the realm of political possibility. In Advocata’s 2019 report on the state of state enterprises, a few key reforms were identified.

These reforms were chosen because they are politically feasible and because they will have a targeted impact on the root causes behind SOE losses. Two of the main reforms are detailed below.

  1. Conduct a survey of all state-owned enterprises: it is impossible for the government to regulate or monitor these entities, when the government is uncertain of the scope of its responsibility. Once the survey is completed, the government can institute basic reporting procedures.

  2. Strengthen COPE, COPA and the Auditor General’s Department: these institutions are the main source of accountability for state-owned enterprises and as such should be given a mandate which allows them to take sufficient action.

Once these steps are taken, the government could expand its reform agenda to encompass the OECD principles of corporate governance, which include clearly defining the state’s role as an owner, establishing an effective legal and regulatory framework for SOEs, ensuring transparency and disclosure, while emphasizing the state’s responsibility to stakeholders. In short, the OECD guidelines will nudge SOEs towards a path of transparency and efficiency.

However, in the short term, the first two reforms mentioned above remain crucial.

SL SOE Count

The COPE reports

Originally appeared on Echelon

By Ravi Ratnasabapathy

The Parliamentary Committee on Public Accounts (COPE) reports on state enterprises

The COPE, a key oversight committee, is by its own admission under-resourced. It lacks staff, particularly for audit and legal support. They also lack IT systems and, apparently, even a proper office. Despite these limitations and the fact that the reports are not comprehensive, they have examined a limited number of issues in a few institutions. These reports are a devastating critique of the state of governance, underlining the need for a re-think in the role of the government.

Excerpts from the reports are as follows:

SRI LANKA PORTS AUTHORITY: RS 5.8 BILLION TO CONSTRUCT SURIYAWEWA CRICKET STADIUM

As per the Auditor General’s report on the SLPA (2016):
“The Authority had conducted the architectural and construction activities of the international cricket stadium in Suriyawewa on behalf of the institute of Sri Lanka Cricket. According to the contract agreement entered into between the contractor and the Authority on the said construction, a sum totalling Rs5,838 million, inclusive of the interest amounting to Rs2,881 million, had remained payable to the contractor by the Authority up to 31 December 2016 in respect of the said constructions made under the variation order (emphasis added) of the contract for construction of the Hambanthota Harbour.”

Note: A variation order is an alteration to the scope of works in a construction contract in the form of an addition, substitution or omission from the original scope of works. While these are not unusual in large projects, it is bizarre to treat work on an entirely new and unrelated project as a variation in a port construction contract.

“Despite the non-availability of any verification that the said sum would be borne either by the Treasury or the institute of Sri Lanka Cricket, the sum had been accounted in the financial statements of the Authority as being receivable from a Government institution, but the receipt of that sum remained doubtful”(ibid).

Separately, the third COPE report observes that Sri Lanka Cricket owes the State Engineering Corporationan amount of Rs818 million on 7 projects as at 31.12.2015.

PEOPLE’S BANK DUD LOAN

1. NON-PERFORMING LOANS AT RS395 MILLION – KANDY CITY CENTRE
An overdraft facility of Rs245 million and a long-term loan facility of Rs150 million were granted to a customer for a construction named Kandy City Centre on 30 January 2009 and 27 January 2009, respectively. However, these loans were classified as non-performing loans after 3 months. Though the customer agreed to pay the loan in installments of Rs1 million per month, it was decided to offset the loan against the monthly rent to be paid on behalf of the People’s Bank branch housed at Kandy City Center.

However, even if the customer repaid the loan in monthly installments of Rs1 million each, the bank would have to wait for 62 years to recover the outstanding amount. The chairman stated that several such unsystematic transactions had been done.

Note: As per CBSL guidelines, ‘Credit facilities repayable in monthly installments: when 3 consecutive installments, principal and/or interest, have not been paid’ are to be classified as non-performing loans.

The loan granted in January 2009 was classified as non-performing within three months of disbursement, which indicates that there was no attempt at repayment. Subsequent to COPE recommendations, Rs20 million had been recovered. Legal action had been instituted, but the defendants did not appear in courts when the case was called on 1 December 2016.

Credit approval in a bank should go through multiple levels of authority – the branch manager, credit officer, credit committees, board committees and risk management committees – depending on the size of the loan. A loan in excess of Rs100 million would typically require approval at the highest levels. The chairman’s comment of ‘unsystematic transactions’ seems to indicate serious control weaknesses, further examples follow.

2. NON-PERFORMING LOANS GRANTED BY JA-ELA BRANCH AT RS619 MILLION
The Ja-ela Bank branch had granted three loan facilities and three overdraft facilities to a customer, his spouse and an enterprise; and subsequently, these loans were categorized as non-performing.

I. At the date of 12.11.2013, the outstanding balance of Rs619,867,345 of the three overdraft facilities and one loan facility could not be recovered.

II. The chairman stated that legal action has been taken to recover more than 60% of the loans that had been granted in an unsystematic manner and discussions are being held with regard to the remaining portion of the loans.

Note: Subsequent follow-up by COPE indicates that the husband and wife were directors in a company engaged in property development. Loans had been obtained in the names of the individual directors and the company. The unsettled balance of these loans was Rs197 million and the interest to be collected was Rs503 million, making the sum total due to the bank Rs700 million by September 2016.

AIRPORT AND AVIATION SERVICES

1. Rs. 7 MILLION FOR THE CONSTRUCTION OF KATARAGAMA HOLIDAY RESORT
Rs7 million had been paid to a private party in 2002 to purchase land to construct this holiday resort. Thereafter, the Kataragama Divisional Secretariat informed that the land belongs to the government and that it had been obtained on a 30-year lease from January 2008 for an annual lease of Rs460,000. However, the sum of Rs7 million paid to a private party had not been recovered.

Note: Following the COPE report, legal action had been instituted in the Gampaha District court for recovery of the Rs7 million. The question as to why the title was not properly checked prior to purchase remains unanswered.

2. AIRPORT AND AVIATION SERVICES LIMITED: RS248 MILLION PAID ON A CONTRACT SIGNED FOR RS27 MILLION TO DEVELOP AN ERP SYSTEM. THE PROJECT WAS NOT COMPLETED.
The contract had been awarded to a private company for Rs27,464,632 (without VAT) in June 2012 for the implementation of the project within 8 months. The company had paid a sum of Rs248,600,000 (without VAT) to the contractor and the period of the contract had been extended on four occasions. Though over four years have lapsed since the awarding of the contract, the contractor had failed to carry out the contract properly. The work of this institution has currently been suspended and it has submitted an appeal.

SRI LANKA TOURISM DEVELOPMENT AUTHORITY

1. SPENT A TOTAL OF RS113 MILLION ON FOUR OCCASIONS FOR WORK THAT WAS NOT CARRIED OUT
A sum of Rs11 million out of Rs29 million had been received for renovating 30 rooms of a holiday bungalow belonging to the Authority had been for work not done and overpaid taxes. According to the report obtained by the Authority from ICTAD, a loss of nearly Rs5 million has been incurred. Steps had not been taken to recover that amount from the contractor or the officer who approved the payment.

A sum of Rs3.2 million had been paid to suppliers based on three letters, which the suppliers had produced stating that they had provided dozers to construct the Kalpitiya Mohottuwasama Jetty. This payment had been made without a certificate of fixing work hours according to the daily meter reading by an officer of the authority.

Even though the Kalpitiya integrated Tourism project commenced in 2008 on an estimated cost of Rs5.5 billion in order to construct holiday resorts with 4,000 rooms and infrastructures facilities to be completed within 5 years, not a single room had been constructed despite an expenditure of Rs88.7 million at December 2014.

2. PAID RS7.3 MILLION AS PART OF THE INTEREST OF A LOAN OBTAINED BY A PRIVATE HOTEL
Four hotels had been selected close to the Hambantota International Cricket Stadium (which was selected to host cricket matches for the 2011 Cricket World Cup), to develop accommodation facilities.

It was revealed that this sum of Rs7.3 million, a portion of the 4% interest of a loan obtained by the Peacock Beach Hotel from the Bank of Ceylon, had been paid out of the Tourism Development Fund on a number of occasions. According to the documents furnished to this committee, the approval of the minister in charge had not been obtained to make the payments.

Note: A letter appended to the COPE report provides some explanation of the circumstances of this payment. It indicates that the four hotels had to be upgraded to four-star status in order to host the 2011 World Cup matches. The hotels had apparently informed the SLTDA that there was no commercial viability to the exercise and requested that the government subsidise the interest cost on the loans required to finance the upgrade.

The cost of upgrade for three hotels is indicated as being “Rs414 million”. The upgrade cost of the fourth hotel was apparently not available. The letter was written by the Director General of the SLTDA and addressed to the Secretary of the Ministry of Tourism had been copied to the Bank of Ceylon, People’s Bank and Hatton National Bank. The interest rates on the loans were supposed to be 12% and the SLTDA was supposed to pay 4% as a subsidy. Based on these figures, the subsidy for the three hotels would amount to Rs16.5 million annually, assuming loans to the values indicated were granted. It is not known if this was the case and if further liabilities exist.

NATIONAL WATER SUPPLY AND DRAINAGE BOARD

There was a cost escalation of 338% in 11 water supply projects that were funded by a bank loan of Rs54 billion. The board has received an unsolicited foreign-funded project, and work has commenced without a contract. Strangely, the NWSDB has been appointed as a sub-contractor on the project by the main contractor, to the value of $64 million (it appears that the unsolicited proposal was accepted by the NWSDB and the work has later been sub-contracted to the NWSDB itself).

Lanka Mineral Sands Ltd. spends money on tasks that are contrary to the objectives of the company – Beach Park The company’s welfare funds have been utilized for the construction of roads and buildings in various other areas in contravention to the objectives of the institution. Information pertaining to spending Rs40 million for the construction of the Hambantota Beach Park and spending money for making improvements to the Devinuwara Maha Devale have come to light.

A veil of incorporation or a shroud of secrecy?

Originally appeared on Echelon

By Ravi Ratnasabapathy

SOEs incorporates under the companies act

State-owned Enterprises (SOEs) in Sri Lanka come in a bewildering variety of forms, ranging from departments, authorities, boards and state corporations, to limited companies. The traditional forms are the first four, which are usually created by a special act of parliament. The advantage of this is that it creates direct accountability of the SOE to the parliament.

When SOEs are formed through acts of parliament, they are subject to the stringent financial and administrative regulations of the state and are obligated to report to the parliament.

The Companies Act is intended for use by private businesses and the principal accountability is to shareholders. There is no obligation under the Act to comply with the regulatory and accountability mechanisms that govern state entities.

The Auditor General reports that, unless the majority of shares are owned by the government, even the audit of limited companies is beyond their purview. Therefore, the recent trend for increasing numbers of SOEs to be incorporated under the Companies Act instead of by an act of parliament is unusual. A list of 452 state entities includes 149 incorporated as limited companies, a fact that the Auditor General (AG) has drawn attention to in his Annual Report of 2016:
“In recent years, it was observed that a considerable number of limited liability companies have been incorporated under the Companies Act by certain Public Enterprises and the universities even sometimes without the approval of the Cabinet of Ministers.”

Another trend is the evolution of complex corporate structures within SOEs, some having multiple subsidiaries and associate companies. The list includes 100 subsidiaries and 19 sub-subsidiaries. Is there a rationale for this? A perusal of the COPE and Auditor General’s reports reveals some systemic problems (examples are highlighted in the boxed sections).

Even within the private sector, complex corporate structures present governance challenges as risks can lie undetected within subsidiaries/associates. These risks, if left unchecked, can expose the group to significant liabilities, and the same is true for SOEs. Vigilance of subsidiary activity is essential for risk management and compliance, but as the AG notes:
“However, it was observed that most of the Public Corporations do not exercise their controlling power over the subsidiaries although their members constitute the majority of the Board of Directors” (Auditor General, Annual Report, 2016)

A classic example is the Ceylon Electricity Board, which has some 22 associate companies, subsidiaries and sub-subsidiaries. Such structures are difficult to penetrate, obscure transparency and leave room for corruption.

The subsidiaries may provide goods and services to other companies within the group via transfer pricing arrangements instead of open tendering. When the directors or key management of these companies are also employees or associates of the parent body, it gives rise to serious conflicts of interests that are difficult to avoid; a point highlighted by the first COPE report.

The failure to disclose details of related party transactions (with subsidiaries) was one of the reasons that compelled the AG to qualify the audit opinion on the financial statements of Ceylon Electricity Board for 2013.

The Ceylon Electricity Board had eight contracts with LTL Project (Pvt) Ltd , a related party to build transmission lines and strengthen infrastructure. The value of four contracts amounted to Rs5.9 billion; the values of the others were not disclosed in the report. Contrast this with the governance of listed companies. Local listed companies are now required to have a Related Party Transactions Review Committee made up of independent directors who must review and report on related party transactions to the Board. The CEB has failed to disclose details even to its auditors! In some cases, it appears that complex group structures have evolved to conceal transactions, hide assets, divert revenue streams or simply enrich connected parties; the very reason such structures are also encountered in instances of money laundering. Some selected examples appear below.

If we leave aside for the moment the government accountability mechanisms and simply view SOEs as businesses, how good is their governance record? The critical tests for a private company are the auditors’ report and timely publication of reports. An analysis in the COPE report of 2014 showed that, of 46 institutions that were reviewed, only 15% had unqualified or clean audit reports. A full 75% of reports were qualified, while 4% were disclaimers of opinion and 6% failed to submit accounts. Things were not much better in 2017. The AG notes that, of 218 entities reviewed, only 80 (36%) received ‘clean’ audit opinions.

These are shocking revelations and the problems appear to be systemic. The complex structures created under the Companies Act seem to provide a shroud of secrecy that hampers oversight and enables systematic corruption. A select list of examples is listed here. The government should shine some light on the dark corners of these SOEs, first by compiling a full list of entities and second by implementing basic regular reporting structures to establish a minimum degree of control.


Electricity Piracy

THE ARBITRARY NATURE OF THE SUBSIDIARY AND SUB-SUBSIDIARY COMPANIES OPERATING UNDER THE CEYLON ELECTRICITY BOARD AND THEIR LACK OF RESPONSIBILITIES TO THE BOARD

The Committee on Public Enterprises undertook a study on the members of the Boards of Directors of 20 subsidiary companies operating under the Ceylon Electricity Board and observed that the same person represents the Boards of Directors of many of those companies.

For example, the Committee observed that the chairman of the Ceylon Electricity Board is a member of Boards of Directors of 6 subsidiary companies, which enables him to take different positions in regard to the same issue, thus jeopardizing the main aim of the Board to provide electricity to the consumers at an affordable price. The following traits of the subsidiary companies operating under the Ceylon Electricity Board were identified: Taking steps to retain a majority of dividends in those companies The Ceylon Electricity Board has no control over those companies. It was observed that the meetings of the Board of Directors of those companies are not represented by an official of the ministry or the Treasury. Those institutions are informed only of matters of specific importance Even though the Ceylon Electricity Board holds a majority of shares of these companies, they are reluctant to be responsible to the Board.


At Arm’s Length?

PEOPLE’S BANK: CONSTRUCTION WORK WORTH RS1.9 BILLION BY SUB-SUBSIDIARIES

The People’s Leasing Property Development Company, a sub-subsidiary company of People’s Bank that was established through the People’s Leasing Finance Company, has made 13 construction works worth Rs1.96 billion.

An unusual payment of Rs11,000 per square foot, exceeding the ordinary payment of Rs6,000 per square feet, was made in the case of these construction works. Further procurement processes have not been followed, and a Bill of Quantities has not been prepared.

The chairman has stated that a decision has been taken not to award construction contracts to this company at the moment and to carry out construction work by People’s Bank itself.


Unauthorised Formation Of Subsidiaries To Perform Services For The Group?

THE FOLLOWING FOUR PRIVATE COMPANIES WERE FORM ED UNDER THE ROAD DEVELOPMENT AUTHORITY:

1. Maganeguma Emulsion Production Company (Pvt.) Limited
2. Maganeguma Consultancy and Project Management Services Company (Pvt.) Limited
3. Maganeguma Road Construction Equipment Company (Pvt.) Limited
4. Expressway Transport (Pvt.) Company

“It was discovered that neither the ministry nor the authority possessed any information regarding the methodology that had been adopted in establishing the aforesaid companies as per the decision taken by the Cabinet. It was further discovered that share certificates and records of minutes were not available, and that annual general meetings had not been conducted.”

COPE requested a report from the Attorney General around all matters related to the ownership of these four companies, on the matters that should be examined at ministry level and on the significant matters that should be examined in a criminal investigation. (COPE Report, 2014)


Dud Number

SRI LANKA TELECOM’S RS108 MILLION ACQUISITION OF SKY NETWORK LTDv

“Even though Sri Lanka Telecom had purchased 75% of shares of Sky network Ltd. for Rs108 million to obtain the frequency required for the continuation of service related to WiMax technology, the company had been closed down after a couple of years with no adequate business activities done on the ground that the technology had become obsolete. The transaction looks suspicious as the said company, which had been formed in 2006, had carried out no business activities other than retaining a frequency until it was purchased by SLT in 2008. It was also revealed that Rs10,468,000 had been paid as director fees during the period in which the company did not function and the person who had been paid as such had happened to be a director at Sky network Ltd”. (Page ix) (COPE Report 2014)


Wholesale No Transparency

REFUSAL TO SUBMIT ACCOUNTS OF SUBSIDIARIES TO AUDITORS

“It was revealed that account details of C.W.E. Construction and C.W.E. Securities had not been submitted to the Auditor General despite reminders being sent and replies to only 13 out of the 26 audits queries had been submitted to the Auditor General.” (3rd COPE report p7). COPE also notes an instance of selected employees drawing two sets of salaries, from CWE and its subsidiaries (p10).

Monster monopolies

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

Originally appeared on The Morning


By Dilshani N Ranawaka

Rukshani, is a small business owner running her own grocery store. Her peak hours of business are when everyone gets back home from their jobs around 7-8pm after working in Colombo. Unfortunately, she has been struggling to make ends meet as of late, due to power cuts that are also scheduled in her area around the same time as her peak hours. With just candles lit during these hours, refrigerators and coolers switched off, it adds an additional cost for her to operate her business.

Thilina, who works in Colombo faces a challenge of getting back home as the workers of the Railway Authority have decided to go on strike asking for a pay raise. Even though trains are over-crowded, they are unfortunately the fastest way of commuting back and forth. Alternatively, Thilina has to resort to the next best solution in his capacity; buses, which incurs an additional cost to reach home.

How is that Rukshani and Thilina have no say over the situation? Why does Rukshani have to suffer losses during the peak hours of her business and why should Thilina have to look for alternative transportation for something they are capable of paying, but somehow is beyond their control?

Trains and electricity are two vital services for the day to day functioning of the country. Why do these authorities continue to function when they are failing to provide reliable and efficient services to their customers who pay for these services? They have a monopoly over this service, hence they exploit it.

As of 2017, Sri Lanka Railway (SLR) sums up for Rs. 7.5 billion in losses. The Central Electricity Board (CEB) projects of Rs. 89 billion in losses for 2019. An island-wide poll by Sparkwinn Research, commissioned by Advocata Institute indicates that 81% of the sampled population are not satisfied with the performance of the State Owned Enterprises (SOEs). As the numbers have spoken, people are clearly not in favour of having these underperforming SOEs.

Poll on SOE satisfaction

Would a private institute still run under these terrible, burdening losses?

The issue mainly starts with the monopolistic control over services complemented with organized trade unions within these public institutions. The fact that these services do not have competition, offers a fundamental background for wage increases and other demands that usually result in strikes which influences the entire population.

The initiation of these services dates back to the years when the private sector had inadequate resources to facilitate these services. In such conditions, the government established these entities for the benefit of the population. However, due to the monopolistic nature of these establishments, workers were able to unionize forcing the government to lose control over these institutions.

To add on to the burden of failures, is the fact that all these are controlled and heavily subsidized by the government. The lack of incentives to improve their efficiency and productivity are therefore felt heavily by the government.

There are common practices of addressing the issues on monopolies of the economy. Incentivizing merger policies, regulating and controlling the quality of these monopolies and price caps are some of the methods developed countries use to provide better services.

The “P” word; “privatization” is a taboo in Sri Lanka, although it is commonly agreed that the process of privatization paves the way towards an answer to address these issues that burden the entire economy.

“Privatization” in Sri Lanka is identified as “transferring an institute from public ownership towards private ownership”. This is only one such form of privatisation and is known as a “complete privatization”.  However, there exists various forms of privatizations such as transferring assets, Public-Private Partnerships and franchising.

Path towards privatization

The process of privatization should be methodological. Montreal Review (an independent online magazine) identifies few principals that would lead to an efficient privatization process.

  1. The purpose of privatisation

  2. The need to review different methods of privatisation

  3. The extent of the privatisation

  4. Recognising constraints

  5. Finding a buyer

  6. Implementing an investor friendly environment to attract investors

How the United Kingdom excelled in their privatization process of trains and telecom are case studies which could be replicated in Sri Lanka. The United States government remained in control of quality control and maintaining standards while the operations were handled by private sectors. On the other hand, the United States had successfully privatised industries with natural monopolies such as water and electricity supply by the privatization of operations with the government remaining in control of providing the role of maintaining standards while removing excess burden on the budgets.

However, given the extensive amount of State Owned Enterprises (SOEs), an initial step towards privatization could be to list down possible institutions or even better, towards creating an index which could be a measurement towards qualifying for privatization process.

Can we breakdown these natural monopolies? Are monopolies simply an excuse that gives the governors the luxury of political lobbying? Something to think about.

“The very term “public consumption products” is an absurd one. Every good is useful “to the public”, and almost every good may be considered “necessary”. Any designation of a few industries as “public utilities or services” is completely arbitrary and unjustified”  - Murray Rothbard, a prestigious American Economist.


Behind the invisibility cloak: Sri Lanka’s hidden state-owned enterprises

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

Originally appeared on The Morning


By Dilshani N. Ranawaka

Is the Government aware it has gazetted 527 SOEs?

Unveiling an invisibility cloak of the state was the first task I did as a fresh graduate. Behind 55 strategic State-Owned Enterprises (SOEs) identified by the Ministry of Finance (MoF) lies another 450+ SOEs making their contribution to the “Coordination Problem”.

SOEs in Sri Lanka

Even at face value, it seems unlikely that a small country like Sri Lanka needs the government to run a pool of SOEs as large as this. Interestingly, the MoF doesn’t have a count of all its SOEs, with the Annual Report only mentioning that there are 400+ SOEs. However, there are at least 527 SOEs, subsidiaries and sub-subsidiaries gazetted. To be specific, the 527 SOEs can be broken down to 424 principals, 84 subsidiaries and 19 sub-subsidiaries.

Of the 400+ SOEs that the government is aware of, the Department of Public Enterprises tracks the profits and losses of only 55 SOEs, which they have identified as ‘strategic’.

This raises two questions.

  1. Why doesn’t the government know the number of enterprises it runs? Anyone running a business should at the very least know the number of organisations it is in charge of.

  2. Why does the MoF only track 55 SOEs? What are the losses that come from the remaining 450?

Let’s take the Ministry of Power and Energy and Business Development for example. The ministry’s losses add up to a cumulative net-loss of Rs. 363,945Mn during the past 11 years. The ministry governs 4 principal SOEs, 6 subsidiary SOEs and 12 sub-subsidiary SOEs adding upto a total of 22 bodies.

When one further explores these subsidiaries, it is quite logical to ponder the rationale for these categorizations. For instance; the Ceylon Electricity Board has two subsidiaries under it. The first subsidiary Lanka Electricity Company (LECO) has three sub-subsidiaries LTL Transformers, LTL Energy, and LTL Galvanizers. The second subsidiary LTL Holdings (Pvt.) has another sub-subsidiary LTL Energy (Pvt.). Is it any wonder that we have erratic power supply? A convenient way to track all these entities would be to establish all of them under one subsidiary; LTL Holdings.

It is time we question the logic of establishing so many SOEs, given that their profits and losses are not tracked, and a majority do not even publish annual reports. When the losses incurred by these entities are added to the equation, it is clear that there is large-scale mismanagement taking place.

The multiple layers of incorporation (principal, subsidiary and subsidiary bodies) enhances the divisibility of responsibilities. Furthermore, the problem with having too many entities makes it hard for them to be monitored. Since SOEs are governed by the state, the debt burden is weighed heavily on the government and then transferred to the taxpayer.

Moving beyond the profits and losses of these enterprises, an equally shocking fact is that out of the 527 SOEs that have been gazetted to date, information of their purpose (classification as commercial and non-commercial entities) of 284 SOEs is not freely available, and cannot be found from government sources.

Can these 527 enterprises be utilized or do a majority need to be shut down because of their losses? The government cannot afford to keep bailing out its mismanaged enterprises - the fiscal space simply does not exist.

The first step to addressing the problem of SOEs, is to figure out the number of entities the state governs. A bi-annual census of SOE conducted by the Department of Census and Statistics, with detailed reports (a current requirement fulfilled only by 55 SOEs) on every SOE is a must.  It is only from here, when the government has an idea of the extent of the problem that we can move into questions of improving accountability and introducing better governance structures.

The question remains, when the government is unaware of the number of entities it is responsible for, why should citizens pay for their loss making, inefficient, institutional excess?  

Sri Lanka has a total of 527 State Owned Enterprises out of which regular information is available for only 55. The inefficiencies and mismanagement which riddle our SOEs are explored in the Advocata Institute's new report  “State of State Enterprises in Sri Lanka- 2019". To read more on SOEs and download full report visit www.advocata.org.


Dilshani Ranawaka is a Research Executive at the Advocata Institute whose main research areas are public finance, behavioural economics and labour economics. She can be contacted at dilshani@advocata.org or @dilshani_n on Twitter.

Sri Lanka’s political system: A Failure of Governance

Originally appeared on Groundviews

By Ravi Ratnasabapathy

This essay examines failures of governance in Sri Lanka. Although discussed within the context of State Owned Enterprises (SOE), they affect many other aspects of public life.

The weaknesses in the governance of SOEs stem from those embedded within the larger political system. These problems can be assessed by an examination of the political system, understanding the incentives of actors and the effectiveness of institutions in directing these towards the public good.

Some examples of general weaknesses in the political system

  1. The power of interest groups

  2. Campaign finance

  3. Weak parliament and committees

  4. Citizens as shareholders

The power of interest groups

People may commonly assume that political actors are mainly concerned with public interest and that the state exists to carry out the wishes of the public.

Unfortunately, the State is made up of people and the dominant motive in people’s actions in the marketplace – whether they are employers, employees, or consumers – is self-interest.

When individuals become politicians they do not suddenly abandon their personal interests and turn into public-spirited individuals who make morally correct decisions in the ‘public interest’.

While most people will base some of their actions on charitable instincts only in rare cases are these likely to be primary motives. Politicians are no different, acting to please interest groups that support them, pushing policies that lead to re-election and pursuing other personal agendas.

 Politicians take collective decisions. They are made by politicians on behalf of the public, and not by the public themselves. All decisions involve a trade-off in costs and benefits but when an individual makes an economic choice, they experience both the costs and the benefits. Thus, they will only act if it is in their interest.

In collective decisions, whether they involve giving jobs to graduates or building a road, the beneficiaries (e.g. graduates, road users) are not always the people who bear the costs (taxpayers or homeowners whose property is lost). Further, in a market transaction both sides have to agree, if either disagrees, they can walk away. In political decisions those who disagree cannot walk away, they are bound to accept the decision and bear whatever costs the collective choice demands.

Therefore collective decisions, unlike individual ones, carry wide implications. Good politicians should weigh overall costs and benefits on our behalf to determine if ‘social welfare’ might be increased by the right choices. The question is do Sri Lankan politicians have the motive; or even the capacity, to do so?

When political decisions are made how do we determine what is ‘best’ for ‘the people’? Society is complex, made up of different groups with different interests. The young may be interested in education and jobs, but pensioners may be more concerned with old age security and health care. An ageing population may vote for increased pensions, but if this is achieved at the cost of lower spending on education the young may lose. Different decisions involve different stakeholders with varied interests, making it difficult to identify a single ‘public interest’.

When collective decisions are taken a choice will be made between many competing sets of interests: but only one set of interests can win. Politicians face conflicting pressures from lobbyists, businesses, family and friends. Those with the greatest leverage will win. This is not the same as saying that policies that bring the greatest social benefit will win.

Small, homogeneous groups (trade unions like the GMOA or businesses) find it relatively easy to organise and have a great deal to gain or lose when collective decisions go for or against them. The opposite is true with large groups, such as consumers or taxpayers.

With large groups the impact of collective decisions on a single member is small so they have little incentive to lobby. Being so diverse, they are also difficult to organise.

The result is that concentrated interest groups have a powerful incentive to organise and campaign for policies that will specifically benefit them. By contrast, the general public, with very diverse interests, have little motivation to put effort into public debate.

The protective tax (roughly Rs.10) on a loaf of bread may not amount to much to a consumer but to the flour millers this represents a gain of around Rs.20 billion a year.

When particular groups manipulate policy to win preferential tax or legal privileges this results in a substantial transfer of wealth from the public to privileged groups. In Sri Lanka the practice is widespread; witness the plethora of special tax concessions (about 200 according to the Finance Minister) exclusive import licenses, permits and protective tariffs.

Campaign finance creates incentives for corruption and poor governance

Limits on campaign spending and the need to disclose sources were removed in the 1978 constitution, opening the floodgates. This excludes the majority of citizens, including the educated, from politics.

There are no accurate estimates of the cost of an election campaign but a former Secretary General of Parliament recently stated that this was in the region of Rs. 60-70 million. Conversations with other commentators produced estimates between Rs. 50-100 million, rising to Rs 150 million for those fighting for preferential votes.

The proportional representation system has increased constituency size (campaign costs are proportional to constituency size) while the preferential voting system intensifies political competition (not only must candidates battle other parties, they must also fight within the party). The combination has sparked an arms race in campaign spending.

While costs are lower outstation they are still substantial and far beyond the lawful earnings of an MP who earns a monthly salary of Rs. 54,285/- plus other allowances of around Rs160,000/-.

Politicians turn to wealthy backers, some connected to the underworld, to fund campaigns and provide labour-in return for political protection or rewards. The result is that a group selected on the basis of access to cash and a workforce – not intellect or ability – enters Parliament. Moreover, the need to recover campaign spending means they come into office under obligation to their sponsors, carrying an inbuilt incentive to corruption.

This has undermined the technical capacity of the state; how can proper policy be formulated if the politicians and bureaucrats are ill-qualified to perform the necessary analysis? The bureaucracy has an important role in policymaking, providing objective assessment of policy options, drawing on experience and practical considerations. Unfortunately, decades of nepotism have sapped its capacity. The concept of independent policy analysis does not exist in Sri Lanka, leaving a vacuum vulnerable to capture by special interest groups.

Weak Parliament and committees

Political actors will pursue their own interests, but functional governance systems can check the worst of these impulses. The most important is parliament, which works through questioning government ministers, debating and the investigative work of committees, principally the Committee on Public Expenditure (COPE) and Committee on Public Accounts (COPA) which scrutinise expenditure.

Unfortunately, serious deficiencies exist. Engineering crossovers in return for political office reduces Parliament to a rubber stamp. Thus there is little incentive for MPs to take Parliament seriously. Many don’t even attend.

An analysis showed that less than half the MPs attended at least 75% of the sessions. Even those who attend remain in the house only for the first hour. Attending funerals or weddings is the priority; they recently voted themselves a new monthly allowance of Rs.100,000 for gifts at functions. Once elected, the goal is Cabinet appointment, as this presents opportunities for gain or furthering political careers. Once ensconced, the incentive is to enjoy office, not to risk the privileges by questioning authority. The multiplication of the Cabinet is driven more by the need to lure opposition MPs to maintain a rubber-stamp majority than strictly functional requirements.

The committee system is also weak. Until recently they were ‘Consultative Committees’ chaired by a Minister and structured to aid the executive than hold it to account. With the major overhaul of the system [1] by the Yahapalanaya government – a significant if little known reform in the last three years – these are now known as ‘Oversight Committees’ and their function is now much better geared to scrutiny and accountability-but much more needs to be done.

COPA/COPE are under-resourced; their reports complain of a lack staff (particularly audit) and proper IT systems. Further, the government is not required to act on the recommendations of these committees (although ministers must now respond to findings) within any stipulated period of time, leaving the accountability loop open.

Despite many limitations, these committees have uncovered multiple grave malpractices that point to fundamental control weaknesses. The fact that only a minority of institutions seem able to furnish an unqualified audit report suggests much more lurks undetected.

Citizens as shareholders

If politicians do not hold SOEs to account can citizens, the ultimate “owners” exert any meaningful oversight? Unfortunately not because:

  • They have no legal standing as owners;

  • The fragmented nature of the “ownership” creates a collective action problem: no one citizen, even ones who are seriously interested, has an incentive to bear the costs required to monitor the managers.

Oversight is costly, and time and effort must be spent on monitoring performance if malpractice is to be detected. This task is made more difficult as citizens lack ready access to information. As no direct rewards accrue to a diligent citizen from such action there is little incentive to expend the effort to do so; citizens depend on politicians to do this. As discussed previously, the politician has no clear incentive, especially since they are not held accountable for poor performance.

The main mechanisms to address these two layers of agency costs are corporate laws and political and legal institutions. The weaknesses of the political institutions have been discussed above and corporate law are rarely enforced on SOEs.

To take a few simple examples; of the 55 large SOEs only ten had published an annual report for 2016, as per the 2017 report of the department of Public Enterprises. (The law requires publication within six months of the year’s end. Timely disclosure is essential in a robust corporate governance framework as it provide the basis for scrutiny for stakeholders.) Thirty were two or more years in arrears.

Sri Lankan Airlines has suffered a Serious Loss of Capital [2], but the legal procedures that must follow have been ignored. Even the labour laws are not enforced-the JEDB has unpaid EPF liabilities of Rs.323m but earns no sanction.

Therefore, the performance of SOEs suffers from both political costs (i.e. the costs associated with control of firms by politicians who have political goals that differ from economic efficiency) and agency costs (i.e. the costs resulting from managerial pursuit of private benefits at the expense of the firm), leading to chronic inefficiency and underperformance.

Conclusion: a dysfunctional state that serves political interests

The political process incentivises corruption. A weak governance regime means little accountability and few checks on government spending. In addition, limited technical capacity means policy is open to “capture” by special interests. The combination is deeply dysfunctional: a parasitic system that transfers wealth to the politically connected through corruption and rent-seeking.

The weaknesses in the political system are discussed here in order to place the context within which the agency and political costs of SOEs are experienced. Poor oversight magnifies these costs. In combination with the perverse incentives of politicians it gives rise to the blatant breaches of fiduciary responsibility that occur, repeatedly in the COPE reports.

All political systems need to mediate the relationship between private wealth and public power. Those that fail have dysfunctional governments, captured by wealthy interests.

The ramifications of this are far-reaching. Although a full discussion is out of place here, structural weaknesses could explain why a massive expansion in state activity has yielded minimal visible benefits to citizens. Between 2005-15 total government spending quadrupled (from Rs.584 billion to Rs.2,290 billion) with little noticeable improvement in essential services; transport, health, education or waste disposal.

The money is swallowed up in a massive administrative machine. There is endless duplication in the 32 cabinet ministries, 3 non-cabinet ministries, 107 departments, and 24 spending units, 452 SOEs just at the centre. Most developed countries make do with about 20 ministries.

The problem with endemic corruption is that public officials, both bureaucrats and politicians, may redesign programmes and propose projects with few public benefits and many opportunities for private profit.

In Sri Lanka, patronage wins elections which may be why we have 166,588 peons and 25,645 drivers in public service (but only 19,612 medical officers and 32,399 nurses). The public sector workforce ballooned from 850,267 to 1.35m between 2005 and 2016.Salaries and pensions consume almost half of all tax revenue. Much other government expenditure has been funded by debt: but it is only now; when debt is repaid-and taxes rise, that the true cost becomes apparent to the public.

Structural problems require structural solutions; changing the identities of the people who hold public office will not suffice.

A concerted effort to improving oversight is needed, to overcome the resistance from within (as it is not in their interest). The National Audit Bill to strengthen the Auditor General’s role to increase accountability was only passed in July 2018, after being held up since 2003. Requests to open the COPE/COPA hearings to the public by the Committees’ themselves have gone unheeded.

Improving accountability and governance within State Owned Enterprises is important because of the large leakages that take place, but this will address only the subset of a larger problem.

Sri Lankan intellectuals have long placed great faith in government but given the quality of governance the role that the state should play in public life should be reassessed. The governance mechanisms are what ensure that state activity delivers benefits to citizens. A state that exhibits high levels of governance may be trusted to play a larger role, whereas one with weaker governance should only play a smaller role.

Keynes stated the function of government: it should do only what the people could not do at all, not what it could do better than the people. Our objective should be a state that performs a limited and well-defined number of tasks to which it is suited and has the requisite capacity.


[1]. Ministers are now required to submit responses to committee findings (previously they could be ignored), COPE follows the convention of being chaired by an opposition MP and non-COPE members of Parliament may now observe its proceedings

[2]. As per Section 220, if it appears to a Director of a Company, that the ‘net assets’ of the Company are less than 50% its ‘Stated Capital’, then the Board, within 20 working days of such fact becoming known to the Director, shall call an Extra-ordinary General Meeting of the Shareholders to be held, not later than 40 working days from the date of calling of such Meeting. Sri Lankan Airlines has lost the entirety of its capital and now has a negative capital.


Sri Lanka has a total of 527 State Owned Enterprises out of which regular information is available for only 55. The inefficiencies and mismanagement which riddle our SOEs are explored in the Advocata Institute's new report  “State of State Enterprises in Sri Lanka- 2019"

To read more on SOEs and download full report visit www.advocata.org

In state business, the agency problem is on steriods

Originally appeared on Echelon

By Ravi Ratnasabapathy

Inefficiency in state enterprises is a common, if not universal, problem. Citizens are often frustrated by poor service at public institutions. Public hospitals are free, but how many senior executives use them? When holidaying overseas, Sri Lankans will use the railway, but when was the last time they rode on Sri Lanka’s subsidised railway?

Where there is a choice – private hospitals or cars – people may escape poor state services by using alternatives; but the poor aren’t as fortunate.

However, there is no escape from the cost of inefficiency. Inefficiency and waste in state enterprises must eventually be paid for, either by high prices (needed to cover all the waste) or higher taxes. Why is this common in Sri Lanka, but less so in developed countries? The issue is with governance, specifically the problem of agency.

The principal-agent problem is common to any enterprise, private or public, not directly managed by its owners. When an owner manages a business, the interests of the business and the owner are perfectly aligned. When the owner hires a manager to run the business, problems arise if the interests of the manager conflict with that of the owner.

When an owner manages a business, the interests of the business and the owner are perfectly aligned. When the owner hires a manager to run the business, problems arise if the interests of the manager conflict with that of the owner

The problem with state enterprises is that, apart from the standard agency costs of a business, they also suffer political costs. We will come to this presently, but in effect, two sets of costs must be managed for a state enterprise to function effectively, so the regime of governance needs to be much stronger than for private entities. In Sri Lanka, the governance regime is a lot weaker, leading to underperformance and abuse.

DEFINING THE PROBLEM OF AGENCY
Shareholders, the ultimate owners of a company, as principals, elect the management to act and take decisions on their behalf. Managers are supposed to employ the resources of the business in a manner that will maximize shareholder wealth. The manager’s best interest, however, is to divert these resources to enhance their personal status (through perquisites such as chauffeured limousines, business class travel) and maximise their own wealth (through excessive pay or corruption).

An example may be seen in recent news reports of a payment of Rs75 million paid to senior managers of People’s Bank and allegedly excessive payments to the top management of SriLankan Airlines. According to a COPE report, the ETF has paid incentives amounting to Rs74.8 million and bonuses of Rs44.5 million, contrary to treasury circulars. Another instance is Hunter and Company PLC, where the auditors were dismissed when they insisted that disclosure was necessary with regard to a bungalow that was being used by key management personnel. Later, a shareholder of the company moved to convene an EGM to call for an explanation from Hunters’ directors with regard to the “disappearance of a Rs2.5 million cheque in favour of a Mr Mahesh Gajanayake and about directors’ remuneration over and above the limit set out in the company’s Article 107”.

The reduction of agency costs is regarded as the essential function of company law and corporate governance.

THE PROBLEM IN STATE ENTERPRISES: POLITICAL AND AGENCY COSTS
State ownership creates its own agency problems, which are caused by the separation of politicians and bureaucrats who oversee SOEs from “the citizens” on whose behalf the enterprises are ostensibly owned. This creates an extra level of agency.

SOEs are ultimately owned by citizens, but run by managers, who are controlled by politicians. Politicians determine or otherwise influence the appointment of key management and must hold the managers accountable.

Unlike shareholders, politicians have not invested their own money in the business. As they have no stake, there is no particular interest in ensuring that it is well run. Politicians, however, have incentives to direct SOEs to achieve economically inefficient objectives for political purposes, giving rise to political costs. These may be benign, if policies enhance social welfare, even if they fail to maximize shareholder value, but most often they are malign, favouring political allies at the expense of public welfare.

The real owners, the citizens, have no voice and little interest in how the business is run.

CITIZENS AS SHAREHOLDERS: THE COLLECTIVE ACTION PROBLEM
Citizens are the ultimate “owners”, but cannot exert any meaningful oversight as:
(a) they have no legal standing as owners; and
(b) the fragmented nature of the “ownership” creates a collective action problem: no one citizen, even ones who are seriously interested, has an incentive to bear the costs required to monitor the managers.

Oversight is costly, as time and effort must be spent monitoring performance if malpractice is to be detected, a task made more difficult as citizens lack ready access to information. As no direct rewards accrue to a diligent citizen from such action, there is little incentive to expend the effort to do so; they will depend on politicians for this. As discussed previously, politicians have no incentives to do so.

The main mechanisms to address these two layers of agency costs are general corporate laws on the one hand, and general political and legal institutions on the other; but for reasons discussed later, they are weak.

Therefore, the performance of state-owned enterprises (SOEs) suffer from both political costs (i.e. costs associated with the control of firms by politicians who have political goals that differ from economic efficiency) and agency costs (i.e. costs resulting from managerial pursuit of private benefits at the expense of the firm), leading to chronic inefficiency and underperformance.

THE AGENCY PROBLEM: A DISTINCTION BETWEEN PRIVATE AND PUBLIC
As observed above, the agency problem is present in all corporate entities, but it is important to note a fundamental distinction between private shareholders and citizens.

Investors in private companies take a risk when they put money down, but it is one taken of their own volition. Shareholders subscribe voluntarily to shares; they are not compelled to invest.

Generally, people only invest in private companies if they know and trust the management. If the business does not perform to expectations, they will earn a lower return. If it fails, the shareholders will lose, but it is their own money, voluntarily invested, that is lost.

With SOEs, the important difference is that, unlike in a company where willing investors are taking conscious decisions, the investment in an SOE is by citizens who contribute involuntarily and unwittingly. Taxation is compulsory, and in the form of indirect taxation, all citizens contribute to SOEs.

In the most extreme case, if shareholders are disgusted and can find no remedy, they still enjoy a final option: exit. They may sell their shares. For citizens, unless they choose to migrate, there is no exit option.

Businesses must risk their own money when they go into trade, but governments risk other people’s money. If a business does not earn a profit, the owner will need to keep infusing funds, and this provides a powerful incentive to improve efficiency. If the owner is incapable of improving the business and is unable to infuse more funds, a mismanaged business will eventually close.

SOEs in Sri Lanka, however, enjoy implicit state guarantees and funding via state banks, which undermines even the threat of bankruptcy as a source of managerial discipline. The continuous accumulation of losses is only possible because of this factor. An example is SriLankan Airlines, which has accumulated losses of $1 billion and a negative net worth, but continues to operate with funding from state banks. For context, the current IMF facility (stand-by arrangement) is $1.5 billion.

THE PROBLEM OF AGENCY WITHIN THE POLITICAL CONTEXT OF SRI LANKA
As citizens lack the interest or wherewithal to monitor SOEs, efficiency is entirely dependent on the system of governance. Distorted incentives and weakened mechanisms present structural challenges to efficiency.

Investors in private companies take a risk when they put money down, but it is one taken of their own volition. The investment in an SOE is by citizens who contribute involuntarily and unwittingly.
  • Patronage
    Politics in Sri Lanka is based on patronage. Ministers face pressures from constituents for jobs or favours. State sector jobs are especially prized for status and security. Politicians believe that granting jobs is a necessary condition for re-election. In general, lawmakers and ministers in Sri Lanka across party lines and ideological divides view SOEs as providing avenues to create employment.

    SOEs incorporated as limited liability companies enjoy greater autonomy in the management of their affairs, allowing the minister to bypass treasury or budget restrictions placed on recruitment. In the case of state banks, it is possible for the minister to exercise patronage by directing lending on preferred terms to selected constituents.

    This leads to problems of over-staffing. The more staff are hired, the greater the potential votes, leading to the chronic over-staffing evident in many SOEs. The allied problem is nepotism – the recruitment of people based on relationships instead of ability. Recruiting unsuitable candidates weakens the general level of competence within the SOE, which adversely impacts performance.

    Therefore, patronage is particularly harmful as it has a dual impact on performance; the hiring of excess staff adds to unnecessary costs, while nepotism leads to diminished efficiency.

    A COPE report highlights how the State Engineering Corporation recruited 4,512 employees when the available vacancies were only 41. The problem is pervasive. The Secretary to the Treasury Dr. Samaratunga noted that recruitments to SOEs take place without the approval of the Management Services Department of the Treasury. “All SOEs across the government—public corporations, statutory boards or government-owned companies—have effected recruitment without proper approval of the management services”.

  • Corruption
    Corruption is endemic in Sri Lanka’s political system. The root of the problem lies in campaign finance. Changes in the 1978 constitution removed limits on campaign spending and the need to disclose sources of funding. This has led to a massive increase in spending with candidates seeking to outspend each other in order to win. Those who succeed come into office having either made major investments or incurred significant debts, usually a combination of both. This creates an in-built incentive for corruption. In the absence of strong governance mechanisms, it is hardly surprising if MPs do not succumb to temptation. spending a good deal of their time in office either recovering election spending or raising funds for their re-election campaign. This explains the scramble for positions in the government, which allows control over resources. The greater autonomy of SOEs makes them particularly tempting targets.

Greater efficiency can only be expected through better governance, which requires addressing fundamental weaknesses in the political system and adopting a comprehensive system of corporate governance for state enterprises

LACK OF A COMPREHENSIVE SOE CORPORATE GOVERNANCE FRAMEWORK
The Secretary to the Treasury has noted that SOEs have a “general lack of governance practices, lack of accountability mechanisms, issues associated with lack of clear policy and legal frameworks, and weak supervisory roles played by the management and board of directors”.

Many countries have adopted comprehensive corporate governance practices to strengthen the governing bodies that oversee and control (shareholders or owner meetings, board and management, internal monitoring structures), while defining clear rules of engagement between the different actors, as well as increasing transparency and accountability towards stakeholders.

These are lacking in Sri Lanka, and the overall system of governance still seems inadequate to hold SOEs to account.

Conclusion
Perverse incentives and weak governance greatly increase political and agency costs of state-owned enterprises. It is, therefore, not surprising that a study by Lalithsiri Gunaruwan found that “inefficiency is a common feature in all Sri Lankan SOEs, across all organisational categories”. Greater efficiency can only be expected through better governance, which requires addressing the fundamental weaknesses in the political system and adopting a comprehensive system of corporate governance for state enterprises.

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.

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