Not cost of living but quality of life

Originally appeared on The Morning

By Dhananath Fernando

The gentleman who cleans and repairs my roof every month is the breadwinner of a family of four, and a father to two children who are still schooling. He earns a living working for a company for an end-of-the-month salary, but it is paid based only on his working days. I often ask him: “How is life?” He always grins and provides me with the same answer: “On payday Rs. 5,000 is worth just Rs. 50. One week before payday, Rs.50 is worth Rs. 5,000.” 

I recalled what he said when recently, a Minister stated in Parliament that “the Rs. 5,000 was given for a month, not to be spent within a week”. Things took an emotional turn following this statement and social media castigated him for being tone-deaf and being detached from ground realities. 

This makes complete sense from the receiver’s point of view. Rs. 5,000 is not adequate for a family of four! A simple calculation breaks it down as follows: Rs. 1,250 per person per month, which means about Rs. 42 per person a day, and about Rs. 14 per meal, even if the calculation is based on the rather broader and irrational assumption that the money is only spent on food.

According to the Household Income and Expenditure Survey by the Department of Census and Statistics, Sri Lanka’s mean household expenditure per month is Rs. 54,000.  In the estate sector, which is in the lowest part of the income pyramid, it is about Rs. 34,000. On average in Sri Lanka, food expenditure is Rs. 19,140 per month and even in the estate sector, it is at Rs. 16,890. This is according to data for the year 2016. Bearing this in mind, if we add 5% inflation every year, the expenditure must be significantly higher today.    

It is painfully obvious that an allowance of Rs. 5,000 is not at all adequate for a month’s expenditure. However, in defence of the Government, it was communicated that the Rs. 5,000 was not a stipend and is adequate for a month as a supplement for people whose livelihoods are affected. The Government reiterated that this was a form of financial assistance to help them keep their nose afloat in these trying times. It is no secret that the Government is running a massive budget deficit to the extent of 8.9% of GDP in 2021. Therefore, providing Rs.5,000 is also a challenging task, given the strained and limited financial resources. 

This points to just one conclusion; that nobody but poverty is to be blamed for the current circumstances. Sadly, as a country, we are in denial of this fact.   

Let’s look one step further. Our inability to tackle poverty is our own doing. We have failed over and over again, from one successive government to another, to set our fundamentals in the right direction. Unfortunately, we still continue to drift ignorantly in the same wrong direction.  

Sri Lanka’s workforce is highly state-dependent and the island’s massive inclination towards a welfare state is far beyond our affordability or financial capacity. Politicians promise long lists of free supplies from fertiliser to sanitary napkins and to even jobs in the government sector. It is a vicious cycle of politicians cheating people and people cheating themselves, owing to their enormous reliance on the State. This unsustainable codependency has today shoved the island to one of its worst economic calamities since independence.

Starvation-driven crowds protest in the streets of Colombo requesting for more money. The Government is struggling to make repayments to our external creditors; $ 4 billion on average over the next four years. Our reserves stand at $ 5 billion in total with the Government still running a significant trade deficit.

Why is the cost of living high?

Our cost of living has always been a much-discussed topic over the decades. The real reason why it’s high is because we are very unproductive as a country. Despite low labour costs, our production tends to be expensive and unproductive. We spend about 20-50% more than the average price on some essential goods. In certain product categories, it goes beyond 100%, which is almost double. Our products are not competitive on a global scale. Consecutive governments have failed at making reforms that are required to make them competitive. Our tax structure is 80% indirect tax and 20% direct tax, where most of the basics, including food items, are subjected to a tariff. That is one reason why most of the gazette notifications which are released are on tariff revisions. When this happens, every government becomes the victim of their own policies when the cost of living starts rising.  

 We often look at increasing local production but fail to consider improving local manufacturing and competitiveness. Global benchmarks are forgotten. We continue to ignore the consumer. As a result, higher incomes become meaningless in Sri Lanka as our quality of life continues to deteriorate. For example, even if you have a vehicle, it is difficult to commute and if you are in business, there are way too many interventions and bureaucracy. If you use the courts as a means of conflict resolution, the matter takes decades to be resolved. Thus, we don’t really meet the basic requirements for a satisfying quality of life or ease of doing business. 

Solution

There is only one solution – hard reforms to make Sri Lanka’s products competitive. We can make products competitive through competition. We can compete and be competitive only if we increase productivity. Darwin’s theory of evolution that only the fittest survive is still very much valid. The problem is that we have failed to grasp the reality that we must evolve with the changing times.

If we continue to disregard the need to evolve our fate, it will be catastrophic and a payday where we feel that Rs. 5,000 is actually worth Rs. 5,000 will be a distant dream. If the hard reforms are not prioritised and pushed through, all Sri Lankans will live forever in that week before payday, just like that nice gentleman who cleans and repairs my roof. 

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

A roof over your head or a castle in the sky?

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

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By Dhananath Fernando

As Sri Lankans, we are conditioned to have 4 priorities in life: 

1. Get a degree 

2. Build a house

3. Buy a car

4. Be a good citizen.

While this is the mantra of every teacher and every parent, the system in which we live and work in is filled with barriers. Let’s take the first goal for example. Before you get a degree, the first step is getting into school. Entering grade 1 is a painful and tedious process and even if you succeed, only about 7% [1] of school leavers will have the opportunity to enter a state university. What happens to the remaining 93%? The rest are dependent on external degrees, vocational training and private education institutes for their tertiary education.

Every dream we are conditioned to hustle for does not come easy. What is truly terrible is that the system also prevents you from realising your dream through hard work. Let’s analyse the case of owning a house. 

Is the dream of owning your own home a realistic one?

I recall a recent conversation with my retired parents. “After pouring all of our EPF/ ETF, gratuity and housing loans and spending every cent kept we had saved for medical treatments, we still could not finish the ceiling and the light fittings of this house”.

My parents’ house was hardly anything fancy. It was a simple, single story, 1500 sq ft structure with basic amenities. This is the most common form of most Sri Lankan houses, even after pouring years of money and energy into building them.

The statistics by the Ministry of Housing and Construction [2]  shows that more than 250,000 families live in temporary houses and more than 400,000 families live in houses with roofs with galvanized sheets. Another 386,000 families live in partly constructed houses; either the floor is not cemented, or the walls are not plastered. Isn’t it a very poor performance for a country categorized as Upper Middle Income by the World Bank? 

Why is this so challenging?

The challenges of building a house are numerous and varied, from settling land disputes to finding a good contractor, the list continues on. A major factor that is often not included in this list of woes are the taxes on building and construction material that results in exorbitant raw material prices. The prices of these items are high, but we rarely question why.

Here is a breakdown of border taxes of a few raw materials:

• Wall tiles and floor tiles: 107%

• Construction steel: 90%

• Sanitary ware (Commodes, squatting pans): 62%

Graph by JB Securities

If you have ever attempted to build a 100 square foot basic toilet you may have realized how expensive material and labour can be. My focus is on basic sanitary facilities and not a 5-star grade bathroom with a bathtub and expensive fittings. How can a population afford to build a basic bathroom when their steel is taxed at 90% and their wall tiles and floor tiles are taxed at 107%?

The consequences of the tax create a chain reaction where individuals spend nearly two times greater than the actual price for steel in your basic construction. The reason why most of the houses are incomplete and most of the people becoming house builders for a lifetime is that they spend money for basics like steel, wall tiles and many other basic units double the actual cost and then inevitably run short on cash for the completion.

Why do these high taxes persist?

The purpose of high tariffs is to discourage the importation of construction material which is already available for a very reasonable price with higher quality in the global market. The excuse subsequent governments provide is that this is done to protect the local manufactures, but what is the rationale behind this kind of protectionism? Tariff protection is often provided for local manufactures, to give them breathing space in which to grow, and innovate up to the point that they catch up with global competition. However, this industry has been protected for a few decades and the lobbying gets stronger every year for more protectionism.

Is it fair to keep half of our population in temporary and incomplete houses as a result of tariff rates as high as 107% on basic material required for construction? Additionally, the purpose of this tax is to discourage some else who produces efficiently and effectively, in favour of more inefficient local production. In economic terms this is called a rent and the businesses who gain from this are the rent seekers – something Sri Lanka has many of. Most of the self-proclaimed successful businessmen are not the ones who have done better than the competition but have minted money from taxpayers by hiding behind government protectionism.

High taxes at what price?

The market contraction as a result of the unfair tariff policy goes beyond what can be seen at surface level. High taxes have an unseen dire impact on other supporting industries connected to construction. For instance, once you spend all your money for steel, tiles and electric materials you will be forced to cut your expenses on furniture, curtains, and other items which are also supplied by local businesses. Most Sri Lankans build a house on a housing loan. In addition to paying off a loan with interest, we also have to pay the rent of 107% on construction material - how justifiable is this? 

This was simply a common man’s perspective. Even when considering industrial and commercial buildings, the situation is no different. For an instant if you are investing on a property in the leisure industry as a result of incurring a greater expense on construction material, one would  have to consider the higher interest rates on loans and recovery of the capital. That higher recovery rate will create higher room rates, making the property almost uncompetitive in the market.

The dream of buying a car and dream of getting a degree is no different from building a house.  Unfortunately, what former Indian president said about dreams is perfectly applicable to Sri Lankan’s dreams of building a house.

“Dream is not that which you see while sleeping it is something that does not let you sleep”. And yes, for the majority of Sri Lankans it’s a dream that doesn’t not let us sleep, keeping us up with worry till the last day and the last hour of our lives.

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[1] University Grants Commission. 2018. Handbook of Statistics-2018. https://www.ugc.ac.lk/downloads/statistics/stat_2018/Chapter1.pdf

[2] Ministry of Housing and Construction, Housing Needs Assessment and Data Survey, 2016.

[3] Calculation by Advocata, using 2019 Tariff Guides 

An ‘unhealthy’ tax regime: Is the Govt. stifling basic needs?

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

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By Anuki Premachandra

This year’s global theme for World Health Day, which falls today, is universal health coverage (UCH) for all. In comparison to most countries in the region, Sri Lanka is in a positive trajectory towards this, with a policy goal to ensure universal health coverage to all citizens through a well-integrated, comprehensive health service.

UHC is a health care system focused on medical service delivery – it predominantly revolves around accessibility, affordability, and availability of healthcare services. However, in the case of Sri Lanka, health needs to be looked at from a broader perspective.
This World Health Day, while commending the country on a great public healthcare system and better access to water and sanitation than most other countries in the region, I’m going to explore the case of how some simple taxes on items that contribute to your health can lead to complicated concerns on your health. Are Sri Lanka’s tax policies depriving you of accessibility, affordability, and availability of proper healthcare, hygiene, and sanitation?

Taxing your menstrual health
Menstrual hygiene is not commonly discussed in Sri Lanka, having very little literature and understanding of proper menstrual hygiene management. This is also probably a reason why a basic item required for proper menstrual hygiene – sanitary pads – have total taxes as high as 62.6% levied on them, despite being a country with 4.2 million menstruating women. More often than not, women are compelled to use unhealthy menstrual hygiene products or practices owing to their monetary conditions. Naturally, an intervention like taxes only worsens this situation. The most appalling of findings is that unhealthy menstrual practices can contribute to cervical cancer, one that unfortunately has proven to fall to the plight of many Sri Lankan women.

Every year, 1,136 women are diagnosed with cervical cancer and 643 die from this disease in Sri Lanka (HPV Centre, 2018). Cervical cancer ranks as the second most frequent cancer amongst women in the country, wherein poor menstrual hygiene management is a direct causal factor of this. Of our population, 52% is women, out of which 4.2 menstruating women stand the risk of being diagnosed with cervical cancer due to poor menstrual hygiene. If we are taxing something as necessary as sanitary napkins that contribute to healthy menstrual practise, are we not then making health a privilege instead of a basic human right?

Taxing your access to proper sanitation
In a recent interview, Senior Advisor at the Sri Lanka Water Partnership Kusum Athukorala stated that the main problem they have had to deal with when conducting sanitation programmes in rural schools is the lack of a proper disposal mechanism for sanitary pads. It is either this or the lack of proper toilet facilities. According to the WHO, although sanitation coverage in Sri Lanka is 92% – the best in the South Asian region – an area that they too have identified as one that requires further development is rural school sanitation. Period-friendly toilets matter.

Additionally, although over 50% of our population have access to household sanitation facilities, diving deeper into the breakdown of these numbers is important. Despite great sanitation coverage, 7.2% of our urban population, 7.6% of our rural population, and 17% of our estate population still rely on a shared toilet facility for their sanitation needs, according to the Household Income and Expenditure Survey 2016. Why then do our rural schools lack proper toilets and why does a portion of our population rely on shared toilets for their sanitation needs? The answer lies in the prohibitively high cost of building toilets.

Total import taxes on sanitary ware like commodes and squatting pans are over 60% and wall tiles, floor tiles, and finishing ceramic are taxed at over 100%. Out of our population, one million people live in temporary houses and 1.2 million people live in underserved settlements. Access to proper toilet and hygiene facilities are very limited in these types of households owing to the exorbitant cost of constructing one. Having access to sanitation is a basic human right, yet a portion of our population suffer on a daily basis from the lack of access to a clean and functioning toilet. Without toilets, untreated human waste can impact a whole community, affecting many aspects of daily life, and ultimately pose a serious risk to health. The issue runs deeper into societal impacts, such as teenage girls often leaving school at the onset of menstruation due to lack of privacy and the risk of contaminating infections due to unhygienic toilet facilities. This narrative needs to change.

This World Health Day, while we commit our country to global goals that provision for more accessible and affordable healthcare facilities for all, let’s also look at health in a broader perspective. In Sri Lanka, universal health coverage can be realised through affordability, accessibility, and availability of better health, sanitation, and hygiene facilities – end taxes on periods and toilets!

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Anuki Premachandra is the Manager – Research Communications at the Advocata Institute. She has a background in public policy with an active involvement in policy communications. She is also an advocate for the reduction of the period tax and contributes to research and policy work in that subject area. If you have any questions or feedback on this article, she could be contacted on anuki@advocata.org or @anukipr on Twitter. Advocata is an independent policy think tank based in Colombo, Sri Lanka which conducts research, provide commentary, and hold events to promote sound policy ideas compatible with a free society in Sri Lanka.

How import taxes drive up the cost of living

Originally appeared on Daily News

By Ravi Ratnasabapathy

“The Lanka Confectionery Manufacturers Association (LCMA) is actively seeking Government intervention to introduce a ‘negative list of manufacturing’ to safeguard local firms engaged in the industry before opening up the economy to giants like India and China.” - DailyFT 25 September, 2017

The above is an illustration of a phenomenon that is common in Sri Lanka – an industry seeking protection from foreign competition. This protection generally takes the form of a tariff – a tax that is imposed on the imported product that is not applied to the domestic equivalent. In the above instance the LCMA is requesting that the existing tariff protection enjoyed by the industry is continued even if a Free Trade Agreement (FTA) is signed. (An item in the “negative list” of an FTA is not subject to the FTA). For example imported biscuits are taxed at a total of around 107% of price, if biscuits are on the negative list this tax would continue, despite the FTA.

Although a tariff is imposed, this does not generally cause foreign exporters to reduce the price that they charge for the product. Therefore the domestic price of the imported product rises by the amount of the tariff.

Domestic producers competing with these imports do not have to pay the import tax so have an advantage over the imported product. As the price of imported products rise, domestic producers have the opportunity to raise their own selling prices because competing imported products now cost more.

Will the domestic producer raise his prices? Yes, it makes no sense otherwise. If the domestic producer were to set his prices at exactly the same level he would if imports were not taxed there would be no point in seeking tariff protection from imports. They very purpose of the tariff is to enable the domestic producer to sell his product at a higher price. The domestic producer is thus better off as a result of the tariff.

What happens to consumers?

Domestic consumers of the product are equally affected by the imposition of the tariff. They must pay a higher price for both imported and local products.

In other words, the protection for domestic industry is actually paid for by domestic consumers, in the form of higher prices.

What of the Government that imposes the tariff?

The government collects tariff revenue, on whatever quantity is imported, although they do not collect it on the local product. The benefit that the Government creates for the local producer by raising the price of imports is collected by the producer. This surplus is called a “rent”, of which more below.

We thus have two domestic winners (domestic producers and the government) and one domestic loser (domestic consumers) because of the imposition of a tariff.

The local producer who is able to charge a higher price from the consumer thanks to the tariff on competing imports is said to enjoy a “rent”. In economics, a “rent”, is an unearned reward. The producer is able to charge a higher price not because of superior quality or service but because a tax imposed by the Government.

If the producer was able to charge a higher price because of better quality, even while cheaper imports were available the producer would be earning the premium price. There is an important distinction here.

Consumers would only buy a more expensive product while lower priced products are available is if they valued what they were getting. The producer must do something extra to persuade consumers that his product is superior and worth paying a higher price.

When a tariff raises the price of imports, local producers are able to charge higher prices with no increase in value to the consumers. Given a choice consumers may well chose cheaper alternatives – but the tariff makes sure that the alternative is no longer cheap. Consumers are thus forced to pay a higher price, not because they want to but because there is no alternative. This is why the premium in this instance is said to be unearned. Consumers do not perceive better value but pay more.

Thus producers gain at the expense of consumers. As noted before, it is domestic consumers (not foreign producers) who pay for the protection of domestic industries. The net impact is a transfer of wealth, from consumer to producer that is facilitated by the tariff.  Is this good policy?

If it were confined to a handful of industries it may not matter much, but in Sri Lanka it is all-pervasive. Over thirty common household items affected are listed below. This is only a selection-many others are affected. It explains why Sri Lanka’s cost of living is so high. All necessities from food (fruit, meats, pasta, jams) to toiletries (soap, shampoo, toothpaste) to household products attract taxes from 62%-101%.

Sri Lankan consumers suffer a high cost of living in order to support domestic industries. There is an argument that supporting local producers to build an industrial base will accelerate growth in the long run.

Japan, Korea and Taiwan practiced industrial policy(IP), but even proponents of the policy admit that care is needed to pick the right industries. In Japan and Korea the main industries were steel, shipbuilding, heavy electrical equipment, chemicals and later cars. Taiwan had light manufacturing (electrical appliances, textiles) before moving to heavy and chemical industries and electronics.

Sri Lanka seems to want to emulate this in toiletries, household cleaning products and food: soap, shampoo, washing powder, floor polish, pasta, cheese and biscuits.

To succeed, industrial policies need to foster a structural transformation in the economy that leads to rapid creation of jobs, especially more productive and better jobs. Selecting the right industries is important.

“it matters how realistically the target industries are selected in light of the country’s technological capabilities and world market conditions” [1]

Krugman [2] summarises some criteria advanced by proponents of IP in selecting sectors:

1. High value-added per worker. Real income can rise only if resources flow to businesses that add greater value per employee.

2. Linkage industries-such as steel and semiconductors. Industries whose outputs are used as inputs by other industries can create a cycle of industrialization. In Japan cheap, high quality steel gave downstream industries-ships, automobiles, rails, locomotives, heavy electrical equipment-a competitive advantage.

3. Present or future competitiveness on world markets. If the industry can meet this test, we can presume that resources are being allocated efficiently. Competitiveness is critical for linkage benefits to flow.

The selected industries need to target exports (albeit not exclusively)– to achieve scale economies and because it provides a “tangible criterion for the policy makers to judge the performances of the enterprises promoted by the government” [3]. The failure to promote exports is the key reason for failure of industrial policy in Latin America. (Chang, 2009)

The exports focus also ensures competitiveness. The purpose of policy is not to protect inefficiency but improve productivity.

Therefore support for industry must be conditional-on meeting performance targets.

“The results of industrial policy (or indeed of any policy in general) depends critically on how effectively the state can monitor the outcome that is desired, and change the allocation and terms of support in the light of emerging  results” [4]

Deliberation Councils were set up in Japan and Korea which would set targets together with industry. To ensure targets were stringent they also involved independent technical experts, academics and others.

Performance would be monitored and targets revised. Where a policy was seen to be ineffective it would be revised. Industrial policy is not only about picking winners but also phasing out losers.

“The success of industrial policy depends critically on how willing and able the government is to discipline the recipients of the rents that it creates through various policy means (tariffs, subsidies, entry barriers). The point is that the suspension of market discipline, which is inevitable in the conduct of industrial policy, means that the government has to play the role of a disciplinarian” [5].

This requires a bureaucracy insulated from political pressure to take impartial decisions on the support to industry-and change or withdraw support, depending on performance.

“How closely the government interacts with the private sector while not becoming its hostage is very important.” [6]

It becomes clear that successful industrial policy is a sophisticated partnership between industry and state, governed by the underlying principles of competitiveness and productivity. Unfortunately what takes place in Sri Lanka is unlike that of East Asia but similar to Latin America.

“Import substitution policies got a bad name, especially in Latin America, because the industries that were created often only survived as the result of protection. It was particularly costly when countries protected intermediate goods, because that made goods farther down the production chain less competitive. Countries often paid a high price for this kind of protectionism, and the maintenance of this protection was often associated with corruption.” [7]

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[1] Chang, H. J, 2006. Industrial policy in East Asia – lessons for Europe. An industrial policy for Europe? From concepts to action EIB Papers, [Online]. Vol 2 No.6, 106-132. (Accessed 07 January 2019)

[2] Paul R. Krugman, 1983. Targeted Industrial Policies: Theory and Evidence. [Online] (Accessed 07 January 2019)

[3] Ibid

[4] M Khan, 2018. The Role of Industrial Policy:Lessons from Asia. [Online] (Accessed 07 January 2019)

[5] Ibid

[6] Ibid

[7] Joseph E. Stiglitz. Industrial Policy, Learning, and Development. [Online] (Accessed 07 January 2019)

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For the full list of taxes on Food Items, Household Items and Personal Care items, click here.

Import Taxes and the Cost of Living

Originally appeared on Echelon

By Ravi Ratnasabapathy

The Encylopaedia Brittanica defines the cost of living as the “monetary cost of maintaining a particular standard of living, usually measured by calculating the average cost of a number of specific goods and services required by a particular group.”

“Cost of Living is the most fundamental measure of well-being; how good a life we can lead, the degree of comfort we have, and the number and types of products and services that we can buy.”

In a modern society everybody is a consumer, no one is self-sufficient. The prices we pay for our food and clothing, our necessities and luxuries, and everything else in between are what determine our cost of living.

Naturally, for anyone other than a committed ascetic this is the most important aspect of life. For any politician sensitive to the public it should top the list of priorities.

A lot of our daily necessities, from food to household products are imported. This should allow us to take advantage global efficiencies to source the cheapest or best products, depending what people want. Unfortunately high taxes and poor trade policies drive up end-costs for consumers in Sri Lanka.

Sri Lanka imposes a variety of taxes on imports: customs duty, VAT, Port and Airport Levy, Nation Building Tax and Cess. Although the maximum customs duty is only 30%, once these other taxes are added the total tax can increase to anywhere from 50% to 100%.

Heavy taxes are imposed on food (meat, dairy, vegetables, fruit, coffee, cocoa, pasta, breakfast cereal, biscuits, jams); personal care (soap, shampoo, toothpaste, diapers, sanitary napkins, shaving cream, razors), household care ( washing powder, wet wipes, polishes, brooms, brushes),  children’s needs (diapers, pens, pencils, pencil sharpeners, toys).

Older generations who experienced pre-1970s Sri Lanka may recall people cleaning their teeth with fingers (using charcoal or something called ‘tooth powder’), scrubbing dishes with a pol-mudda (coconut husk) or washing clothes by dashing them on a rock.

Toothpaste, washing powder, soap and shampoo are no longer luxuries; if they were a high tax may be understandable but they are necessities, even for the less well-off. Perversely luxuries like perfumes, wristwatches sunglasses are taxed the most lightly.

This has a significant impact on overall household budgets and the standard of living.

Voters need to ask our politicians why they need to tax these items so heavily. Baloo, the bear in the Disney cartoon sang of the bare necessities of life. Our leaders need to understand just how far their tax and trade policies are putting necessities out of reach for ordinary people; the main reason why so many seek opportunities overseas. Local salaries cannot keep up with the cost of living.

For full list of taxes, click here.

Some of the tariffs generate revenue for the government but many are imposed to protect local industry. Tariff protection for local industry comes at a cost: high prices for consumers. Supporting local industry is laudable but instead of protection the support should be targeted to help improve competitiveness and productivity. Firm level productivity depends on:

1. the sophistication with which domestic companies or foreign subsidiaries operating in the country compete, and

2.  the quality of the microeconomic business environment in which they operate.

Government support to upgrade technology, worker skills, improve access to capital, R&D and infrastructure is positive. These, together with more efficient government processes, improved infrastructure, more advanced research institutions-in short a healthier business environment; can yield long term productivity gains for the economy and the firm. Competitive pressure provides the incentive to improve productivity; the Government needs to work with firms to help this happen.  

Price protection for local industry is a blunt tool that hurts consumers and incubates inefficiency. Industry has demanded this for centuries; the French economist Frederic Bastiat explored this in satirical essay in 1845 that addresses the essence protection. It is reproduced, in an edited form, below:

A PETITION

From the Manufacturers of Candles, Tapers, Lanterns, sticks, Street Lamps, Snuffers, and Extinguishers, and from Producers of Tallow, Oil, Resin, Alcohol, and Generally of Everything Connected with Lighting.

To the Honourable Members of the Chamber of Deputies.

Open letter to the French Parliament, originally published in 1845

Gentlemen:

You are on the right track. You reject abstract theories and have little regard for abundance and low prices. You concern yourselves mainly with the fate of the producer. You wish to free him from foreign competition, that is, to reserve the domestic market for domestic industry.

.....We are suffering from the ruinous competition of a rival who apparently works under conditions so far superior to our own for the production of light that he is flooding the domestic market with it at an incredibly low price; for the moment he appears, our sales cease, all the consumers turn to him, and a branch of French industry whose ramifications are innumerable is all at once reduced to complete stagnation. This rival, which is none other than the sun, is waging war on us so mercilessly we suspect he is being stirred up against us by perfidious Albion (excellent diplomacy nowadays!), particularly because he has for that haughty island a respect that he does not show for us. 

We ask you to be so good as to pass a law requiring the closing of all windows, dormers, skylights, inside and outside shutters, curtains, casements, bull's-eyes, deadlights, and blinds — in short, all openings, holes, chinks, and fissures through which the light of the sun is wont to enter houses, to the detriment of the fair industries with which, we are proud to say, we have endowed the country, a country that cannot, without betraying ingratitude, abandon us today to so unequal a combat.

Be good enough, honourable deputies, to take our request seriously, and do not reject it without at least hearing the reasons that we have to advance in its support. 

First, if you shut off as much as possible all access to natural light, and thereby create a need for artificial light, what industry in France will not ultimately be encouraged? 

If France consumes more tallow, there will have to be more cattle and sheep, and, consequently, we shall see an increase in cleared fields, meat, wool, leather, and especially manure, the basis of all agricultural wealth. 

If France consumes more oil, we shall see an expansion in the cultivation of the poppy, the olive, and rapeseed. These rich yet soil-exhausting plants will come at just the right time to enable us to put to profitable use the increased fertility that the breeding of cattle will impart to the land. 

Our moors will be covered with resinous trees. Numerous swarms of bees will gather from our mountains the perfumed treasures that today waste their fragrance, like the flowers from which they emanate. Thus, there is not one branch of agriculture that would not undergo a great expansion. 

The same holds true of shipping. Thousands of vessels will engage in whaling, and in a short time we shall have a fleet capable of upholding the honour of France and of gratifying the patriotic aspirations of the undersigned petitioners, chandlers, etc. 

But what shall we say of the specialities of Parisian manufacture? Henceforth you will behold gilding, bronze, and crystal in candlesticks, in lamps, in chandeliers, in candelabra sparkling in spacious emporia compared with which those of today are but stalls. 

......Will you tell us that, though we may gain by this protection, France will not gain at all, because the consumer will bear the expense? 

We have our answer ready: 

You no longer have the right to invoke the interests of the consumer. You have sacrificed him whenever you have found his interests opposed to those of the producer. You have done so in order to encourage industry and to increase employment. For the same reason you ought to do so this time too. 

....The question, and we pose it formally, is whether what you desire for France is the benefit of consumption free of charge or the alleged advantages of onerous production. Make your choice, but be logical; for as long as you ban, as you do, foreign coal, iron, wheat, and textiles, in proportion as their price approaches zero, how inconsistent it would be to admit the light of the sun, whose price is zero all day long!

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For the full list of taxes, click here.

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

By Ravi Ratnasabapathy 

The article originally appeared on Dailynews on 7 May 2015

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

It is advisable that the Government reconsider this policy. 

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