The thin line between gaining power and triggering crises

By Dhananath Fernando

Originally appeared on the Morning

The game has begun. The familiar auctioning of non-existent resources during election season is in full swing. Candidates are making various promises without considering the repercussions they will face whether they win or lose.

Candidates are likely contemplating two things: first, promise now, gain power, then deal with the aftermath of those promises. Secondly, if they know they’re not going to win, they might promise the impossible, thinking they won’t have to deal with the consequences. Neither of these approaches is without significant risks and either can lead to disastrous consequences.

Elections and governing a country go beyond mere promises and their execution; it’s about managing people’s expectations with available resources.

After the economic crisis, all indicators suggest we are slowly recovering, thanks to stringent measures. Interest rates have soared to record highs to curb inflation. Urban poverty has tripled, rural poverty has doubled, and the already impoverished estate sector has seen a 1.5-fold increase in poverty.

Apart from our parliamentarians, all citizens have compromised their wealth and earnings. The public has reluctantly understood that tough sacrifices are necessary.

Impossible promises

The promises being made now are simply impossible to deliver. One such promise is a 25-50% salary increase for Government employees. Even the last Budget’s cost of living allowance increment is yet to be fully implemented. According to the 2023 Budget, Government salaries and wages total approximately Rs. 939 billion. Therefore, a 25-50% increase would require an additional Rs. 230-460 billion next year.

Our annual revenue from Advance Personal Income Tax (APIT) is at most Rs. 160 billion. This means that the proposed salary hike would require almost 1.5 to three times APIT. Is the private sector ready to shoulder an additional 150-300% in tax or revenue hikes for these Government salary increases?

Just in July, the Government rejected a proposed Rs. 20,000 salary hike for State workers, stating that it would need an additional Rs. 275 billion, which would require increasing the Value-Added Tax (VAT) by 4% to proceed.

Making matters worse, there are suggestions to amend VAT and many other tax rates by different candidates to align with their earlier pitches.

The danger of these promises is that whoever becomes the candidate who comes into power will need to fulfil all these promises, even those made by their competitors, which are unattainable.

The losing candidate, who will then be in the opposition, will always pressure the government to fulfil these unsustainable promises, raising public expectations for things that cannot be delivered. When expectations are unmet, it typically results in a political crisis, or if they try to fulfil what was promised and it is not economically viable, we will end up in an economic crisis.

That is why elections are not just about gaining power but also about managing people’s expectations.

Making promises responsibly

A salary hike for senior Government officials is necessary, but it is only feasible through a complete restructuring of the Government cadre and our military.

Currently, about 48% of our salary expenditure is for the defence sector, with about 32% going to the military. Restructuring the military is complicated and sensitive. A salary hike without restructuring will disincentivise staff who are expecting to leave, adding a massive burden on Government pensions and leading to a pension crisis.

With the new Central Bank of Sri Lanka (CBSL) Act, the Treasury cannot borrow money from the CBSL or print money. Therefore, if the Government borrows more from the market, interest rates will rise and the overall cost of capital will skyrocket.

The proposals to revise VAT are no different. VAT is a reasonable tax system because it only charges for the value added, unlike other indirect taxes like the Social Security Contribution Levy (SSCL), which has a cascading effect. VAT is easier to collect and it creates minimal distortions. Additionally, high-income earners contribute a higher amount of VAT as their consumption is greater.

The discussion about renegotiating the International Monetary Fund (IMF) agreement needs to be approached with caution. In every IMF review, it is clear that adjustments or shifts in timelines are made based on our performance.

However, trying to renegotiate the entire IMF agreement and its structural benchmarks could invite unnecessary complications. Not only Sri Lanka, but our bilateral partners including China, Japan, and India; multilaterals such as the Asian Development Bank (ADB) and Japan International Cooperation Agency (JICA); and our bondholders have all based their calculations on the existing IMF agreement.

It took over a year to negotiate our current terms. Another renegotiation would be time-consuming, and by the time we reach a settlement, the accumulated interest would be unbearable and market confidence would likely falter.

The damage our candidates are collectively doing is by making promises that cannot be delivered during this crucial time, and people’s expectations are a combination of all these. Whoever wins may have to deliver most of these pledges, which is not feasible. If the winner cannot deliver, a political crisis is certain, or if the winner tries to implement what was promised, another economic and social crisis is assured.

While people must vote carefully, candidates must make their promises responsibly; otherwise, they will start losing power from the very first day they receive it.

The State’s business is no business at all

By Dhananath Fernando

Originally appeared on the Morning

We can’t judge a book by its cover, but in the Sri Lankan Presidential Election, we can certainly gauge many people’s futures based on what is said about State-Owned Enterprise (SOE) reforms.

The simple truth is that we can only progress with SOE reforms. These reforms are rare and even mentioning them on a political stage requires courage. However, the fact remains that there is no future without SOE reforms.

Given the resistance by political leaders, this column is another attempt to reiterate why the State should not engage in business and how State involvement in business impacts all citizens.

Why should the State not do business?

The role of the State is not to do business but to ensure the rule of law. As the saying goes, “When you do something, you are not doing something else.” When the State engages in business, it neglects its primary duty – upholding the rule of law, which is its core mandate.

Another reason the State should not do business is that it has a unique way of participating in every business as a mandatory shareholder through the tax system. Every corporation is required to pay 30% of its profit to the State, which is essentially the Government’s share.

Additionally, businesses must pay an 18% tax based on their income. This means that the Government collects more than 50% of the profit value without doing anything. Since the Government is already collecting money from all businesses, there is no need for it to engage in business directly.

Why sell profit-making SOEs?

A common argument against privatisation is, ‘why sell profit-making SOEs?” The answer is that the State has no role in business, and even if these enterprises are making a profit, those profits must be evaluated against the value of the assets.

For instance, the Sri Lanka Cashew Corporation has an asset base of about Rs. 500 million, but its annual profit is only around Rs. 14 million. This translates to roughly Rs. 1 million per month. Does it make sense to run a business that generates just Rs. 1 million in profit after tying up resources worth Rs. 500 million?

If we had Rs. 500 million, even the safest investment, such as a fixed deposit at a 6% interest rate, would yield about Rs. 30 million per year, which is more than double the profit of the Cashew Corporation. Just because an enterprise is making a profit doesn’t justify the State continuing to run it if we can’t maximise the return on those assets.

What about the SOEs of Vietnam and South Korea?

Like Sri Lanka, both South Korea and Vietnam had significant SOEs in the 1960s due to limited private capital. As private capital slowly developed, both countries began reforming their SOEs. These reforms included privatisations and gradual government withdrawal through corporatisation.

In Vietnam, there were about 5,600 SOEs in 2001, which was reduced to 3,200 by 2010 through various reform packages under the Doi Moi reforms. By 2016, the number of SOEs had further decreased to 2,600, thanks to reforms including Public-Private Partnerships (PPPs) and corporatisation.

Vietcombank, which was a 100% State-owned bank, was listed on the Ho Chi Minh Stock Exchange as part of a pilot project in 1990. The State’s ownership was reduced by 75%, with 15% of the shares sold to Japan’s Mizuho Bank. Similarly, Petrolimex, a petroleum company in Vietnam, sold 9% of its shares to JX Nippon Oil & Energy on the Ho Chi Minh Stock Exchange.

In South Korea, Korea Telecom (KT) was fully privatised by listing it on the Korean Stock Exchange, New York Stock Exchange, and London Stock Exchange. The Korea Electric Power Corporation was also opened to private investors by listing on the Korean Stock Exchange in 1989 and the New York Stock Exchange in 1999. Other companies, like Pohang Iron and Steel Company, Korea Exchange Bank, and Korea Tobacco & Ginseng Corporation, also underwent reforms to allow private sector participation.

Vietnam attracted Nokia as a key investor for economic growth, while South Korea grew with Samsung and other electronics companies. If Sri Lanka wants to progress, we need to bring in world-class operators that can run these enterprises efficiently, rather than have the Government manage them.

Benefits of SOE reforms

SOE reforms offer a package of four solutions to our problems.

First, they boost Government revenue, as efficiently-run companies will generate higher profits, allowing the Government to increase its revenue.

Second, SOEs have significantly contributed to our sovereign debt, and reforming them can help reduce the national debt.

Third, Sri Lanka requires Foreign Direct Investment, and SOE reforms can serve as a channel to attract such investments.

Fourth, SOE reforms can help cut down Government expenditure, as these enterprises currently contribute to massive Government losses.

SOE reforms require political will because incorporating them into a manifesto is unlikely to attract votes; in fact, it may deter traditional voters. However, the moment of truth will come, and ultimately, we all have to face it – it’s just a matter of time.

Why public transport should be the real campaign promise

By Dhananath Fernando

Originally appeared on the Morning

All political parties want to make promises during the election to attract their voter base.

Some politicians in the Opposition provide material benefits such as roofing sheets, sarees, and mobile phones. Additionally, the ruling party often announces salary hikes for Government servants, special interest rates for retirees, fuel cost reductions, and fertiliser subsidies, expecting to provide relief for voters and secure their votes in return.

The biggest benefit voters can receive from politicians and their manifestos is the improvement of the public transport system. A solid mechanism to improve public transport is more beneficial compared to all other promises combined.

However, the way most politicians are opting to provide relief for the problem of commuting is by removing the vehicle import ban. Removing the ban is necessary because our vehicle stock has not been renewed for the last 4-5 years. However, vehicle imports will not solve the problem of public transportation. Not many politicians or parties understand that our economy and many of the other struggles related to the cost of living are connected to the problem of commuting.

Given the poor status of our public transport system, every middle-class family living in suburban areas within a 20-30 km radius of Colombo wants to travel in their own vehicle. To own a personal vehicle, a middle-income family pays about 150-200% in tariffs on imported vehicles. Simply put, this means that middle-class people pay twice the value of a car, often with a vehicle loan taken at about 12-14% interest.

The solution many middle-class families choose to solve their commuting problem comes at a significant cost to their living expenses and lifestyle. As a result, they end up spending two to three times the value of a vehicle at high-interest rates, cutting down on other potential expenditure, such as higher education or investing in a business.

When the middle class cuts down on spending, many other industries that could have benefited from middle-class expenditure are negatively impacted.

Moreover, as middle-class citizens purchase personal vehicles to solve their commuting problems, the roads become overcrowded. Our average speed during peak hours is dropping below 20 km/h. By spending a fortune on a car at a very high-interest rate, we spend valuable time on the road.

During peak hours, residents from the stretch of Moratuwa, Wattala, Pelawatta, Battaramulla, Maharagama, Kottawa, and Homagama take at least one hour to enter Colombo and another hour to return home. Spending two hours a day commuting means that if a person works for 22 days per month for 12 months, they spend about 22 full days (24-hour days) on the road. This translates to spending at least one month out of 12 on daily commuting. We are spending a month in the most expensive and uncomfortable way possible.

Politicians need to understand the need for a solid public transport system, which will not only provide relief for people but also improve our productivity manifold and boost economic growth and investments.

How can we fix it?

Many political parties make only broad statements, but none specify how to solve the problem. An often-tried solution is buying extra buses from India for the Sri Lanka Transport Board (SLTB) or purchasing new train engines or compartments from India. Despite trying this approach for over two decades, the situation remains the same.

Recent data reveals that after Covid-19, the number of bus routes has declined. One notable bus route that disappeared in Colombo was route number 155, which operated from Mount Lavinia to Mattakkuliya.

While the problem is complicated, the first step to solving it is to encourage people to commute to the city using public transport rather than personal vehicles. Therefore, we need to prioritise high-passenger capacity vehicles in traffic lanes. The priority lane system for buses was a step in the right direction, but the condition of the buses remains very poor. Bus owners are already complaining that high costs and a lack of labour are causing them to leave the industry.

The framework for the solution is to provide a public transport option that is less expensive than travelling by personal vehicle and allows for faster commuting with the same level of comfort as a personal vehicle. In terms of buses, the option is to allow more air-conditioned buses and permit them to charge a higher price.

However, the route permit system must be abolished or replaced with a new mechanism where supply and demand can be matched. With the current route permit system, even if there are many passengers on a particular route, no new buses can be introduced. With controlled pricing, service providers have no incentive to improve their services. Therefore, allowing players to enter with different price points is the first requirement.

Secondly, we can consider high-level options such as a Light Rail Transit (LRT) system, where we can tap into bilateral and multilateral funds.

In terms of trains, private investment must also be allowed. For instance, railway stations across the island are generally located at points where real estate values are the highest. With amendments to the Railways Authority Act, private investments can be tapped to generate alternative revenue models for these stations. Additionally, railway tracks, compartments, and operations can be unbundled, allowing different players to enter each segment rather than running it as a State-run, loss-making monopoly.

Solutions for public transport do not lie solely in Government investments. They lie in making regulatory changes that can unleash the potential of capital, allowing players to enter the market according to demand, and making regulatory changes that offer the public more choices.

Let’s hope that the manifestos of political parties will address the above issues in the upcoming Presidential and General Elections.

A new era or more turbulence?

By Dhananath Fernando

Originally appeared on the Morning

• The challenges facing Sri Lanka’s next president

The Presidential Election has been announced. Ideally, by 22 September, there will be a new president with a new mandate from the people.

Sustaining power will be more difficult than winning the election. Generally, from the very first day after assuming office, things start to fall apart. This will be the first election after the ‘Aragalaya,’ and we do not know the ground reality.

The last power transition wasn’t smooth. While there was a democratic element in appointing the eighth President after the resignation of the former, that episode had many dark elements, including a massive economic contraction and impact on human lives.

Focus on economics and corruption

Previous elections had a national element, but this time the focus is completely on economics and corruption. The good news is that the path forward is well defined, including macro targets. The International Monetary Fund (IMF) Governance Diagnostic has provided the main reforms needed to curtail corruption, with timelines and responsible institutions. Most of these are non-controversial.

This time, all candidates will also have to declare their assets electronically. We, as the people, should demand that the Commission to Investigate Allegations of Bribery or Corruption (CIABOC) enforces this.

The new president must deliver on anti-corruption promises because the demands of the ‘Aragalaya’ have not been met yet. However, some promises, like recovering assets overseas, are not easy to execute. Therefore, delivering on the anti-corruption sentiment is challenging.

Delivering on the economic front is equally tough. After debt restructuring, our interest rates will likely remain high. When interest rates are high, the cost of capital is higher, slowing down investment.

For instance, buying a computer to automate manual work becomes difficult when money is hard to source due to high interest rates. As a result, our economy will not grow. If the economy is slow to grow, it invites another crisis. Simply put, if the economy doesn’t grow, our debt will not be sustainable.

In other words, if the economy is slow to grow, it indicates that we are heading towards another debt crisis. The next leader must ensure both growth and stability.

The second piece of good news is that we at least have an idea of what targets we need to achieve on the economic front. Our debt-to-GDP ratio must gradually come down to 95% and our revenue must increase by improving our tax net.

Many promises about increasing Government sector salaries and public sector expenditure are good, but will be difficult to keep.

Limited options

In this context, there are two limited options available to increase money and productivity.

The first is improving productivity in what we already do. Simply working harder and putting in more effort can help. For example, reducing the number of holidays by 10% should increase the economy’s momentum because people will work more. But this race cannot be won solely by working harder. We must also look into channels for improving productivity without capital investments.

One such area is opening up business ventures that change the business format. For example, app-based taxi companies have significantly improved the productivity of both passengers and drivers by connecting potential riders with drivers. Companies like Booking.com connect tourists looking for lodging with small-scale lodging options.

Changing the business model has increased income for many people, reduced expenditure for many, and decreased waiting times, increasing overall productivity. The new leader must leverage this productivity lever.

The second option is to reform State-Owned Enterprises (SOEs) to attract capital. Allowing SOEs to undergo privatisation and Public-Private Partnerships (PPPs) can attract capital through investments. Additionally, rather than incurring losses, private entities can generate revenue for the Government through taxes and improve productivity.

The third option is to release land to improve productivity and circulate capital. Providing land ownership to people allows them to use it as security to unleash capital from the banking system, improving productivity.

Beyond these three options, any president will have limited choices. Relying on geopolitical powers in a highly volatile geopolitical environment may also be unfeasible.

Therefore, the challenge for the new president extends beyond getting elected. The real challenge is navigating the period after the election, which will undoubtedly be tougher than getting elected.

Delaying elections threatens political and economic stability

By Dhananath Fernando

Originally appeared on the Morning

Whenever there is an election, there is always a conversation about delaying it. Already, Provincial Council Elections and Local Government Elections have been delayed. This was the case in 2004/2005 and again in 2019.

One rationale is that, having just achieved stability after a massive economic crisis, we need more time to complete some structural reforms and ensure political stability. On the flip side, how can we execute any reform without the mandate of the people? Operating without the people’s mandate means political stability is the first thing to go out the window.

After the resignation of the former President, the process of appointing a new President followed a democratic process. While it may not have been perfect, there was a democratic element involved. Political parties with a mandate from the people were able to contest, and the candidate who could command a majority of confidence through votes was given the responsibility to lead the country for the remaining term of the previous President.

Despite its flaws, this democratic element brought political stability, which led to economic stability. With the President’s support from Parliament, it was possible to enter into an agreement with the International Monetary Fund (IMF) and continue discussions with external and internal creditors for debt restructuring. The political stability that came through the democratic element in the power transition process made it possible to achieve some level of economic stability.

Uncertainty and economic growth

However, the same democratic process has clear guidelines on the expiry time of the mandate. If we do not follow this process, the system that brought stability will push us towards instability again.

Delaying or attempting to delay elections often prompts political parties and their supporters to demand elections, creating instability as people seek to test the mandate of the public. Delaying an election in the hope of completing unfinished reforms rarely works as planned.

Moreover, postponing elections increases uncertainty. Even holding an election carries some uncertainty, but postponing it intensifies this uncertainty. The biggest enemy of any economic development is uncertainty.

After debt restructuring, the only way out for the country is economic growth. According to agreements with bondholders, we start repaying our interest from September onwards. A year of uncertainty will hinder even the small growth potential we have.

For economic growth, we need investments, and in an uncertain economic environment, attracting investments will be difficult. Falling behind our growth targets due to political uncertainty will challenge our debt repayments and credit rating updates.

International support may not be as easy to secure if the legitimacy of the Government is questioned over a delayed national election. It is true that elections themselves have an element of uncertainty. Especially post-Presidential Elections, if Parliamentary Elections result in fragmented party compositions, we risk returning to a scenario similar to President Chandrika Bandaranaike Kumaratunga’s era, with a Coalition Government barely holding a majority.

Passing bills during a time when growth and structural reforms are needed could face resistance and pushback, leading to maintaining the status quo rather than shifting gears for growth and development.

Having a majority or even two-thirds power does not guarantee that all decisions will be right or fast. As we witnessed, a two-thirds majority Government was short-lived due to misguided economic policies. However, a diluted majority will also bring instability and frequent power changes, causing things to go back and forth.

The solution: A common reform programme

If we think about the country and the people, the only solution is a common minimum reform programme where parties agree on a baseline level of reforms. This ensures that regardless of who comes to power, progress continues. The common minimum programme can start with implementing the IMF Governance Diagnostic, which has recommended significant structural reforms for fiscal, monetary, anti-corruption, and State-Owned Enterprise (SOE) sectors.

If we can at least implement the IMF Governance Diagnostic Report as a common minimum programme, even in case of a drift, it will be slow. Delaying elections, however, will accelerate the drift and slow down existing reforms and growth.

The real challenge will be for whoever comes to power next. If the next government cannot drive economic growth through improving productivity, investment, and efficiency, another collapse is inevitable. A common agreement on reforms is required because the common people care less about who rules the country and more about how their future and standard of living will improve.

Unveiling the true culprit behind economic woes

By Dhananath Fernando

Originally appeared on the Morning

Sri Lankans have a very negative view of imports, which are often portrayed on TV as the problem behind the economic crisis. Not only politicians, but also those who have opinions on our economy subscribe to the idea that imports are the problem.

Our politicians’ favourite pastime is to blame imports and impose various tariffs or ban imports. Banning imports also makes for a very pro-Sri Lankan image, because a common excuse provided is that high imports are damaging to local industries. Accordingly, the banning of imports has been portrayed as a measure to help develop local industries.

A favourite area when it comes to cutting down imports is food imports. Often, media headlines and politicians comment aggressively, even quoting figures on the value of food imported. The middle class, upper middle class, and wealthiest of society often make the argument of needing to save valuable foreign exchange by cutting down food imports.

However, when we consider the data, it indicates the exact opposite. The middle class, upper middle class, and the wealthiest are the ones who consume the most amount of imports in the form of fuel, mainly through personal vehicles and as energy. About 27% of our imports in January was fuel. Fuel is the largest component of our import basket as a single commodity.

What we have imported as food is less than 11% of our total imports. Non-food consumer goods are just 8% of our total imports. Most pharmaceutical products and medicines for patients fall under the non-food consumer goods category, which are primarily consumed by the most vulnerable people in society.

Imported food items are also consumed by the most vulnerable sections of society. Food items such as canned fish, maize, green gram, lentils, black gram, sprats, b-onions, potatoes, and wheat flour are critical food items for the poorest of the poor.

Firstly, these can be stored without a refrigerator, which saves their energy cost. Secondly, they are easily available and affordable compared to many other items of food they consume. Therefore, the request of politicians and academics to cut back on these food items, which comprise less than 11% of our total imports, is nearly impossible to fulfil, and reducing these imports further is tantamount to asking the poor to live in hunger and their children to suffer from malnutrition.

Thirty-seven percent of our import basket comprises intermediate goods, besides food. These are goods required for exports and to produce many things without interrupting the supply chain. For instance while our main export is apparels, our main import is also apparels. Therefore, asking to reduce apparel sector imports amounts to reducing our valuable exports.

In reality, while there persists a belief that imports have to be reduced, it is not the solution it is touted to be. If we have to cut down on food imports, it will lead to increased malnutrition, hunger levels, or food costs for Sri Lankans.

Ways of reducing imports

If we want to bring down our imports, cutting down on fuel is one way to consider. A World Bank study revealed that 70% of the fuel is consumed by the wealthiest 30% of society. Therefore, it only makes sense to maintain fuel prices at market price.

As indicated in the graphs, there is a correlation between high fuel prices and fuel imports. Our fuel imports have decreased when prices are high as people use it sparingly. Compared to January 2023, our fuel imports had declined by about $ 100 million per month by January this year. With the expansion of the economy, this number is expected to slowly grow. Prices can bring imports down without import bans or tariffs.

Another way to reduce fuel imports is by improving public transport. Most of our fuel is wasted in traffic jams as a result of our poor public transportation infrastructure. If we invest in public transport, not only will it reduce fuel imports, but it will also uplift many Sri Lankans and provide significant relief in terms of their purchasing power. Many middle class Sri Lankans pay a 200% tariff to buy a second-hand vehicle at an interest rate of above 12% because they have no other choice but to commute.

Saving foreign exchange

Sri Lanka has been offered many grants, including for the Light Rail Transit (LRT) project, which we turned down on numerous occasions, leading to geopolitical tensions. When people spend less money on commuting and waste less time in traffic congestion, it will not only improve productivity but also their purchasing power, creating many jobs and generating income.

It is an inalienable truth that we need more food imports with different varieties of protein sources for the benefit of the impoverished. Foreign exchange has to be earned through exports, tourism, and remittances.

Saving foreign exchange is a function of the monetary policy or the supply of the Sri Lankan Rupee to the financial system rather than a function of imports and exports. When the rupee becomes expensive, the US Dollar demand decreases automatically because people buy the latter using rupees that they could have used in an alternative manner.

Asking the public to cut down on food imports, which are mainly consumed by the poor, at the expense of allowing the use of more fuel-driven vehicles cannot be justified and borders on cruelty.

Non-negotiable reforms for election manifestos

By Dhananath Fernando

Originally appeared on the Morning

The year 2024 will be an election year. The general flow of events is that each political party and candidate will launch a manifesto of a grand-scale and present their plans for the people and the country. Most of these promises will not be implemented or will only be half implemented. In certain cases, the opposite of what was promised will be implemented. 

Most manifestos are presented in general terms with a target of 20 years ahead with little data. Many manifestos across all party lines are wish lists with no action plans.

In my view, this time there is a slight difference. 

Regardless of the party formation or whoever the presidential candidate will be, there are few reforms that are non-negotiable. Ideally, across all manifestos, there are five basic ideas which have to be the common denominator.

Strengthening social safety nets 

Following the worst economic crisis in Sri Lanka’s history and high inflation, about four million people have fallen below the poverty line. That puts seven million people under poverty. The recent Household Income and Expenditure Survey carried out by LIRNEasia and the World Bank indicates significant poverty levels and aftereffects of poverty due to the economic crisis. As a conscientious society, we need to take care of our poor people with the social safety net. 

The social safety net is not just an allowance. It is a system and a process of targeting the right people, providing an exit route, and with proper administration. The current Aswesuma programme is making some progress with World Bank assistance, but regardless of the political leader who comes to power, it is a non-negotiable condition that social safety nets have to be strengthened and improved. 

The current process has too many loopholes which have to be addressed and improved. Simplifying the process, providing the exit route, and monitoring and depoliticising has to be a continuous effort from the new leadership of the country.

SOE reforms 

Thus far, mandatory SOE reforms have been painfully slow. Many parties with vested interests are trying to delay it until the election. However, the continuation of SOE reforms is a must. 

Colossal losses, interference in the private sector, intervening in markets, creating an unfair playing field, and inefficiencies are a few reasons why SOEs played a pivotal role in Sri Lanka’s economic crisis. SOEs are vehicles of corruption and have diluted entrepreneurship and Foreign Direct Investments significantly. Without reforming SOEs, the future of Sri Lanka appears to be bleak. 

The principles announced by the SOE Restructuring Unit are in the right direction, but the SOE Act and reforms of the Ceylon Electricity Board, Ceylon Petroleum Corporation, and many other networking industries are a must. 

Anti-corruption and governance reforms

Execution of anti-corruption laws and governance reforms is another area which has no room for negotiation. The International Monetary Fund (IMF) Governance Diagnostic and many other locally-developed reports on governance provide direction on what needs to be done. 

Strengthening our Judiciary system, transparency and accountability in our tax system, removing tax exemptions, and repealing the Special Commodity Levy and the Strategic Development Act too falls under governance and anti-corruption reforms, as those acts provide the legal opportunity for corruption. 

There is a strong sentiment from people on the contribution of corruption to the crisis, so taking long-term measures regarding corruption is a must. Anti-corruption and governance reforms go beyond going after corrupt politicians. Rather, it is a system and framework for minimising government influence. Some reforms are complementary and reforming SOEs is also a key component of anti-corruption and governance reforms, as these SOEs play a vital role in corruption.

Following the IMF programme and debt restructuring 

Given the international financial architecture, we have no option other than sticking to the IMF programme. We can negotiate some of the actions that we have promised, but overall indicative targets and reforms have to be maintained. Otherwise, it will be yet another incomplete IMF programme and the debt restructuring process will be in jeopardy. 

Debt restructuring and the continuation of the IMF programme are very much interconnected. At the moment, external stakeholders are concerned about political instability and in fact, the IMF’s first review identifies the political risks for the continuation of the IMF programme. A commitment from any political leader on sticking to the programme will help Sri Lanka in rebuilding relationships with the world.  

Trade reforms and joining global supply chains 

We have to grow our economy to emerge from this crisis. Tax revisions make it likely that growth will slow down and the only solution to grow small island nations like Sri Lanka is through global trade. Our problems regarding global trade are mainly the problems in our own regulations and systems. 

We have to remove our para-tariffs and simplify the tariff structure for a few tariff lines. Not only will this help trade, but consumers will also have a greater choice of goods and services as well as competitive prices. 

On the other hand, the Government can improve the revenue from Customs since at the moment, the high tariffs are a main reason for revenue leakage in the form of corruption. Trade reforms are about growth, minimising corruption, encouraging exports, and assuring reasonable prices. Even at present, after very high taxes, there are levies such as the Special Commodity Levy, Ports and Airports Development Levy, and a huge array of taxes which hinder the competitive nature of our economy.

These five policies, in my view, are non-negotiable. If any administration deviates from them, it is very likely that we will fall back a few miles behind where we started. 

VAT: The good, the bad and the solutions

By Dhananath Fernando

Originally appeared on the Morning

The Value Added Tax (VAT) increase from 15% to 18% and the removal of about 95 items from the VAT exempted list to a VAT applicable list has raised concern among politicians and people alike. 

When taxes change too often, public confusion and erosion of tax revenue both have to be expected. VAT was once 8% in Sri Lanka and then revised to 12%. It was again increased to 15% and finally now to 18%. The VAT threshold was once at Rs. 12 million and later increased to Rs. 300 million. Currently it is at Rs. 80 million and expected to be reduced to Rs. 60 million. 

When the VAT threshold was increased to Rs. 300 million from Rs. 12 million, the number of individuals registered for VAT dropped to 8,000 from 28,000. Our policymakers are discussing expanding the tax base after diluting our tax base through our own inconsistent policies. 

One of the key principles of taxation is stability, according to the Tax Foundation. The other principles are simplicity, transparency, and neutrality. When tax rates and thresholds are changed often, thIMFe markets and individuals react and tax revenue will erode. 

A complicated context 

Sri Lanka’s context is sadly more complicated than many other cases. We have given a commitment to the International Monetary Fund (IMF) on increasing our tax revenue because our interest costs are extremely high. Most of the interest is inherited due to bad financial management over the years and there is very little meaning in blaming each other. 

On one hand, the Government has no other option but to increase revenue through taxation. However, on the other hand, when taxes are increased the economy will contract. Growth, which is also a key requirement for us to emerge from the crisis, will be affected due to the lowered purchasing power of the people. When the economy contracts, tax revenue will also start to decline.  

Given the perennial weaknesses in our tax administration, the Government has selected the most convenient option of VAT to be increased, since it can be collected easily compared to other taxes. VAT is considered to be better compared to other taxes such as the Nation Building TAX (NBT) or the Social Security Levy (SSL), which are considered to be cascading taxes, where throughout the economic process one tax is applied on top of the other. 

This leads to a situation where the effective tax rate becomes very high, but with VAT, tax will only be applicable for the value added throughout the supply chain. Also, high income earners generally contribute a higher VAT in total as VAT is a consumption tax. People with higher incomes tend to consume more, so the more they spend, the more taxes the Government can recoup. 

The negative impact of VAT can be witnessed when it is applied to food items. The poorest of society gets adversely impacted, since their percentage of expenditure on food is very high compared to people who fall into higher income brackets. 

There will be considerable impact on the overall prices for the common people with the new VAT revisions. The price of petrol and diesel is expected to increase by about Rs. 50-60 (provided the other taxes are not changed and global fuel prices remain the same). LP Gas (12.5 kg cylinder) will increase by about Rs. 500-600. 

Prices of solar panels, electronic items, laptops, and mobile phones are expected to rise. This will also have an impact on inflation as well, but we need to keep in mind that inflation is always a monetary phenomenon. With high prices, people may consider cheaper alternatives and supply and demand will readjust, provided we keep our monetary policy right. 

Solutions 

A key solution to bringing down prices of food items is to remove the Special Commodity Levy (SCL) applied to these items. The SCL not only increases prices, but the provisions provided to the minister to impose and remove the SCL overnight opens significant room for corruption. The recent increase of the SCL on sugar to Rs. 50 from 25 cents is a good example of how an overnight gazette creates room for corruption and passes the burden to the people. 

Other taxes on food items including CESS, Ports and Airport Development Levy (PAL), and many other para-tariffs should be removed. There is a myth that productivity can be improved by imposing tariffs on domestic food items. If that is the case, our industries for milk, yoghurt, cheese, and many other food items have to be extremely productive and efficient. Instead of domestic product growth, we see the same producers ask the Government for further protection. 

Tax competitiveness as a framework 

 Moving forward, Sri Lanka has to look at tax competitiveness as a framework for thinking about taxes. In the global context, everything is about competitiveness, including the tax system. As an example, if corporate tax is 25% in competing markets in the region, we cannot increase the corporate tax to 30%, only considering the revenue requirement of the Government. 

At the same time, we cannot compromise our healthcare and education systems, which help to develop better skills through taxpayer money, by bringing taxes unnecessarily down and compromising our tax revenue. In a market system, competition and prices play a key role, and the same is applicable for taxes, FDIs, and many other variables. 

We have to first take the basic steps of improving tax administration. We then have to rationalise our expenditure and spend where we need to spend, thereafter raising revenue by being competitive. A VAT increase to increase Government revenue alone will not solve our macro instability. We have to ensure macro stability by being competitive in all aspects of the economy.  

Looming political and economic challenges ahead of elections

By Dhananath Fernando

Originally appeared on the Morning

“We know what should be done to get the country on the right track, but we don’t know how to get power back after implementing the policies.” This is a popular statement I hear often when I meet quite a few politicians. The truth is that politicians do not know how to get back power because it’s not an attractive solution.

The popular policies that bring politicians into power are the very same that inspire their ousting at the very next election cycle. People hardly object to good policies unless the same politicians instigate false propaganda. The Right to Information (RTI) Act was just one such instance.

As an election is due next year, it is vital to understand and remember our priorities, otherwise our politicians are likely to take a wrong turn and pass the buck back to the people.

In an election year, the behaviour of any political party is to completely abandon rational economic reforms and play to populist narratives that result in outcomes that are the complete opposite, with the motive of coming to power.

Bringing down fuel prices and announcing other types of subsidies are common tactics. This is harmful, especially when those benefits cannot be financed sustainably, or in some situations, brought into life in the first place.

Even if it does not retain power, the newly-elected government will have a tough time preventing plans that have already been put in place and enacting better policies.

Political risk

In the current context, we run a very high risk of our politicians bringing us back to square one; i.e. another economic crisis. This, given the fact that 2024 is set to be an election year, is a recipe for disaster.

All political parties will shift their focus to slowly becoming more populist rather than being driven by objectivity. Therefore, the real risk is going back to another debt restructuring if we fail to grow the economy and our exports.

There are many politicians who do not understand the gravity of the need for reforms. Regardless of which party or coalition comes to power, there are fundamental issues that need to be addressed.

The process is more or less the same as handing over a house with structural issues from one tenant (government) to the other. The new tenant cannot function because neither the previous tenant nor the owner (people) is willing to fix the fundamental problems.

Risk of a second debt default

Given the unstable political environment coupled with a country already going through debt restructuring, the risks of a second debt default are astronomically high. As we are still struggling with finalising the first debt restructuring, adding a second one into the mix will leave us in dire straits.

The second one will undoubtedly be harder, especially given the significant increase in interest rates and being unable to print money with the new Central Bank Act. If we fail to raise money through markets in order to roll over debt and if we are not open to increasing interest rates, the only option we will be left with is to default again. At that point, most likely there will be pressure once again to amend the newly-enacted Central Bank Act to allow money printing.

Of course, that would be an inflationary measure and we will be back at square one with a balance of payments crisis, debt crisis, humanitarian crisis, and likely a banking crisis too.

Solutions: A common minimum programme for reforms

Reforms are easier in the first 100 days of any government. If we fail to enact reforms within the first 100 days, more often than not, no reforms will take place. Failing to undertake reforms in 100 days means a cost of a five-year delay plus many bad policy decisions in the middle, which are costly and difficult to reverse.

Ideally, if key political parties come to an agreement before an election on selected reforms and execute them regardless of who comes into power, it will at least ensure some stability for Sri Lanka. There are many ideas that all political parties have in common.

Regarding State-Owned Enterprise reforms, there is no political party that says the Government should run an airline. Even National People’s Power Economic Advisor Dr. Anil Jayantha, in an interview with Advocata, noted that they did not believe the Government should do any business with hotels.

Accordingly, there are many other similar areas where we can arrive at an agreement with little difficulty. Therefore, regardless of who wins elections, people can win and sustain some of the economic reforms.

The truth is that reforms are inevitable if Sri Lanka needs to move forward and for any political party to sustain its power. Implementing bad policies, especially considering the status of our country, will make it very difficult to sustain power, because then we will be setting the standard for a new normal in economics and politics.

Where is the money behind our politicians from?

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 Thiloka Yapa and Aneetha Warusavitarana

Election campaigns tend to be one of the driving forces behind corrupt practices even after candidates are elected.

Therefore, with a monumentally significant presidential election just over a month away, conversations around the issue of campaign finance and corruption in public office should be gathering steam.

Running a campaign in Sri Lanka is a costly affair; an aspiring candidate needs to connect with people on a grassroots level as well as a policy level. This exercise requires a great deal of manpower, posters, social media engagement, travel, and lots of “buth packets” – none of which come cheap. As a result, adequate campaign finance is a prerequisite for a successful election bid.

The problem lies in the issue of who is providing this finance and whether there are strings attached. If money is being funnelled into an election campaign on the understanding that once the candidate is in power, the financier will be afforded special privileges and benefits, this is when citizens need to be concerned.

Of course, campaign finance is not the root of all evil in the world of corruption. Regulating campaign financing would not address blatant theft within the government, nepotism, irregular procurement procedures, and the handing out of government jobs to political supporters. However, it is a step in the right direction and, interestingly, is something that Sri Lankan law has addressed in the past.

Regulating campaign finance

The Ceylon (Parliamentary Elections) Order in Council of 1946 specifies that a candidate would have to appoint an agent known as the “election agent”. This agent is responsible for the accounting and reporting of all expenses spent on elections, along with a declaration by the candidate. These financial reports have to be submitted within 31 days of the result of the election being published in the gazette. If it is not conveyed within the stipulated time period, the candidate would not be given the chance to sit or vote as a member in the House of Representatives, until such a conveyance is made.

However, this was repealed by the Parliamentary Elections Act No. 1 of 1981. Under this law, the sources of campaign financing would have to be tracked and reported. The fact that non-compliance would prohibit an individual from taking their seat in Parliament provides a strong and effective incentive for candidates to ensure that reporting is completed in the stipulated time period. While this law did not provide caps on spending during campaigns, making these declarations open to the public would provide another avenue through which elected officials could be held accountable.

However, this accountability mechanism is no longer in place. Under the Parliamentary Elections Act No. 1 of 1981, the entire section on reporting campaign finance was repealed, thus removing this avenue of accountability.

Bringing regulations back

The Commission to Investigate Allegations of Bribery or Corruption (CIABOC) has detailed the National Action Plan 2019-2023, aimed at tackling corruption in its various forms. The section on policy suggestions for proposed legislative amendments is all the more relevant in the context of elections. While the amendments proposed to the Bribery and Corruption Act aim to strengthen the powers of CIABOC and increase their ability to tackle corruption across the board, the proposals on campaign finance and asset declarations aim to curb opportunities for corruption in public office.

The proposed legislative framework for campaign finance puts in restrictions and accountability mechanisms on the finances of candidates. This ensures that when an individual comes into office, they do not bring with them the strings and influence of external parties, and are free to prioritise the needs and requirements of their electorate.

While the suggestions do include a cap on campaign financing, the amendments which prevent conflicts of interest and introduce accountability mechanisms may be more practical to enforce.

Restrictions on donations extend to donations made by government departments, companies registered under the Companies Act in which the government owns shares, donations from foreign governments, and organisations registered outside Sri Lanka. The proposed reform also includes a section on accounting and auditing of campaign finances, making this a prerequisite for an individual to come into power and acting as an accountability mechanism.

Beyond campaign financing

Through the proposed amendments to the Declaration of Assets and Liabilities Law, the checks on financing of elected officials continue once they enter office, expanding the scope of the law to encompass the President, private staff of elected officials, provincial council members, and members of local government authorities, to mention a few. The amendments specify that officials would have to submit asset declarations at the point of their initial appointment on a yearly basis while they hold office, at the point of retirement, and for two years post-retirement.

Additionally, asset declarations of the elected official’s spouse, dependent children, and other persons who live with the elected official or have similar ties are also required.

Tackling corruption is a mammoth task, but these reforms could form the backbone of a culture where citizens hold their representatives responsible and demand increased transparency and accountability.

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Yahapalanaya: A tale of confusion and ineffectuality?

Originally appeared on Echelon

By Ravi Ratnasabapathy

“Whenever we send papers for approval, authorities first look at how to stop it. The only way to activate it is to give something and because we don’t, we have to budget 12-18 months – wait 12-18 months where they (authorities) find different excuses not to give approval.”

Many businessmen are disgusted by the state of the government: rules are uncertain and nothing ever seems to get done. Many also claim that things have got more difficult under the Yahapalanaya regime.

Is this true?

The government has two components, elected representatives (politicians) and non-elected bureaucrats. Policies are normally the result of both political and bureaucratic intervention. There is no question that Sri Lanka’s bureaucracy has been decaying for decades, but it now seems to have almost ground to a halt. It is difficult to judge if the bureaucracy has become a lot worse in the past few years – there have been few obvious changes to the system that prevailed before.

What’s changed are politicians, and particularly, a change in the structure of power. What typically used to happen in the past was that when businesses encountered obstacles in the bureaucracy, they would simply approach a politician. Under the previous regime, power was centralised and resided in a few positions.

If a businessman complained to the right channel, a quick response and a firm decision could be expected. These decisions simply cut through all red tape and regulations, which meant the bureaucracy was simply bypassed. The inefficiencies of the bureaucracy thus remained hidden from view.

Under Yahapalanaya, power is diffused and split among warring factions, contributing to an uncertain policy framework. Lacking an overarching vision, few have a clear idea of policy and even fewer are willing to take bold decisions that cut through the bureaucracy. When businesses approach politicians for solutions, they are directed into the maze of the bureaucracy where they experience the grim decline of decades.

This may explain the dilemma, but what is the solution?

Investors shy away from countries where rules are unclear or are constantly changing, and where approvals are dependent on ad-hoc decisions. What is needed are simple, clear rules and standardised processes that deliver predictable outcomes. If X paperwork is submitted, an approval should be received within Y time with no further intervention.

“The solution is not to allow politicians to bypass laws, but to fix the processes”

The solution is not to allow politicians to bypass laws and regulations, but to fix the processes. This will not just help investors and businesses, it helps the public and small businesses who must get approval for many things from cutting a tree to digging a well or obtaining an electricity connection. Migrant women have to submit a myriad of documents beyond those specified in the Circular and make multiple visits to the DS office in order to obtain the Family Background Report.

Small businesses struggle with taxes. The Inland Revenue refuses to issue VAT registration to a new business unless they can show that they have reached the threshold (Rs3 million per quarter), forcing them to incur the additional cost of VAT. Once registered, even if the business later falls below the threshold, they are harassed for payment, even though they are technically no longer liable.

Small businesses and individuals lacking access to politicians have been dealing with these issues all the time. Fixing the processes should be a priority, but this is an enormous task. It can only be approached by multiple taskforces working together.

At the top, there needs to be a central “Administrative Simplification Agency” – promoting administrative simplification “across the board” for businesses, citizens, and the public sector. The central bureau must be supported by smaller teams working in all the departments to cut and simplify paperwork. Outside taskforces, perhaps supported by external consultants, can help with co-ordination and keeping up the pace of reforms. Relevant partners and affected parties can be involved in the administrative simplification reforms, which will contribute to gaining constituency.

The agency must have the highest level of political backing. The approach is to re-engineer processes, cutting redundant regulations, approvals or documents.

The challenge is to balance the use of administrative processes to implement public policies, minimising the interferences of these requirements in terms of the resources needed to comply with them.

All this is back office work that is dull, dreary, difficult and lacks political visibility. No politician will back such a venture as they will get no political mileage from this.

Transparency is needed in the cutting of red tape, which brings public support, builds political capital and sustain reform.

There is a useful model in Peru that set up a tribunal to gather and evaluate proposals from citizens for deregulation, and to check up on how various bureaucracies were responding to the law. To encourage public participation, bright yellow boxes were placed in the agency, government offices, and at all the radio, television and newspaper outlets to make it as convenient as possible for people to deposit their grievances. The media were encouraged to review the grievances they received, and when they saw an astonishing or outrageous story, they took up the cause, creating the kind of public pressure that politicians found impossible to ignore.

“The agency must have the highest level of political backing. The approach is to re-engineer processes”

The tribunal did not cut the red tape. What it did was bring the problems to public view, and involved the public in the process. The body that cut the red tape worked after the tribunal but in Sri Lanka, the mechanism to cut the red tape must be set up beforehand. This must be done without much fanfare, otherwise the public will once again witness the delays in setting up such a body. Ideally, some preliminary analysis should be done beforehand and several solutions must be kept ready for immediate implementation once the publicity campaign is launched. People should experience real results.

The process must also include evaluation and measurement of changes so further improvements can be done. The principle is to first organise and once this is done, as far as possible, to securely digitise. (Current government efforts to digitise are rickety and intrusive, requiring registration via social media accounts, and are prone to failure).

In Peru, over the years the Tribunal was in operation —with the President, by law, in attendance—more than 200 bureaucratic knots were untied. The time previously required to fulfill hundreds of different kinds of official procedures, including obtaining a passport, applying to university and getting a marriage license, was cut across the board by at least 75 percent.

At the end of President Garcia’s term in July 1990, 79% of the population (and 84% of the poorest among them) rated the Law of Administrative Simplification as the best law enacted during the 1985-1990 legislative period.

If the government is willing to take this approach, it can result in a win-win situation for politicians and the country.

The kind of ‘liberals’ we are

Originally appeared on Daily FT

In an Op-ed published in the Daily FT recently, a group called ‘Avocado Collective’ provided a critique of a lecture by Prof. Razeen Sally organised by The Advocata Institute. Whilst much of it is a critique on the lecture, it casts aspersions on the motives of Advocata. We thought this was a good time to explain what the organisation is about and why we exist.

The Advocata Institute was set up in 2016 as an independent public policy think tank focusing on economic freedom. Sri Lanka’s public debate on economic policy has been dominated by those who believe that state intervention is the answer to all our problems. Advocata has sought to present an alternative view. 

Poor policy and governance are at the root of our problems. 

Take for example State-Owned Enterprises (SOEs), a major area of research for Advocata. The 55 largest State enterprises collectively lost Rs. 87 b in 2017, almost double the Rs. 43 b allocated to Samurdhi, the largest social welfare programme in the country. The losses of SriLankan Airlines alone were Rs. 28 b. 

The Auditor General has exposed billions of rupees in procurement corruption and mismanagement in the State and State enterprises. These losses are paid by taxpayers and, taxes are paid by everyone not just the rich. 

Last year alone, the Government raised Rs. 71 b by taxing food. This is partly responsible for the high cost of living in Sri Lanka. Is funding losses the best use of our tax money?

The country has some 200+ State enterprises but no comprehensive list is readily available. Procedurally, State enterprises must be incorporated by an Act of Parliament and be held accountable to Parliament. In Sri Lanka, all manner of entities are incorporated under the Companies Act with no debate in Parliament and minimal accountability.

Audited accounts of the 55 enterprises where more data is available are chronically late. When they are published, they frequently carry audit qualifications. Some – such as LakSathosa – have not submitted accounts from 2010. Poor accountability results in fraud. For example, the Auditor General reported a fraud of Rs. 15 b in rice procurement at LakSathosa. There are many others. 

We need to ask the question whether the running of a supermarket is the proper role of the Government. Or whether there are better ways of achieving the stated policy objectives of running LakSathosa. Similar questions can be asked about many other institutions, including the State Timber Corporation, which had its last two chairmen arrested under corruption charges. 

The State is engaged in economic activities that range from the strategic to the absurd. From hotels catering to tourists to firms claiming to convert polythene into diesel. What public interest do these enterprises serve?

Posing these questions is hardly a neoliberal conspiracy. It is only reasonable to assume a state that tries to do a limited, well defined set of things has a greater chance of success than a one that tries to do everything and failing at great cost to the people

This is particularly relevant since over several decades Sri Lanka’s once-effective public service has been broken. Some have even questioned the capacity of the State to deliver the most fundamental of public goods: the rule of law and a system of justice.

Is there a conspiracy in asking for sound money and low inflation? Is not keeping the cost of living low the most important safety net for the poor?

Protectionism is another problem. Sri Lankan consumers have to bear extraordinarily high prices due to high taxes. Protective tariffs are rampant in common consumer goods such as footwear, electronics and in vital industries like construction. These tariffs serve narrow political and business interests at the expense of all others. 

Tariff reform is naturally opposed by businesses who have a captive market. Their opposition to competition is at least understandable. What is more surprising is the opposition from groups such as the ‘Avocado Collective’ who perhaps inadvertently, find themselves siding with these groups, and indeed Donald Trump, on his views on trade. 

Sri Lanka faces multiple challenges including an unsustainable fiscal position characterised by persistent fiscal deficits and high levels of debt, particularly foreign commercial debt. Tightening global conditions could increase the cost of debt and make rolling over the Eurobonds maturing from 2019, more difficult. 

Uncertain property rights and trade restrictions deter investment, impairing job creation. The State has stepped in to fill the vacuum of jobs, it employs one in every 15 people, but the narrow tax base does not support the superstructure of the expenditure. Resorting to debt to fund recurrent expenditure is no longer sustainable.

The lack of opportunities and the cost of living cause many Sri Lankans to look overseas for advancement.

New challenges loom in health as the population ages while risks from climate change have increased. Is the education system geared to meet the needs of a knowledge economy? There are important questions to be raised on the priorities of public spending as well as the quality and effectiveness of spending. 

We believe that we need to rethink these issues and our objective is to bring alternative ideas for discussion since they are absent in the current discourse. We hold lectures and publish research and commentary, all of which, including videos of lectures are available online at advocata.org and our social media pages. Our public lectures have been open to all. 

We have always been open about our priorities. Our ideal Sri Lanka is one that is prosperous, open and free. A system that allows for maximum individual freedoms, particularly economic freedom. A country where anyone can succeed through hard work, personal responsibility and determination. 

Are these good things? How do we get there? There can be legitimate disagreement. Our role is to provide ideas, stimulate debate and offer practical solutions based on evidence, not to be the ultimate arbiter. 

Shooting down messengers is a spectator sport among Sri Lanka’s political elite. Constructing conspiracy theories is a fanciful, if entertaining, exercise practiced by those trying to de-legitimize real issues and will do little to move us forward.

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By Fellows of the Advocata Institute in response to the article ‘What kind of liberals are these?’ published in the Daily FT, Friday 29 June. More information on Advocata is on www.advocata.org.

Politicians or technocrats?

Originally appeared on Echelon

By Ravi Ratnasabapathy

A layer of technocrats working with ministers can improve policy.

Sri Lanka’s long-suffering citizens face yet another election this month. Many are disappointed by the performance of the current government. The dreary parade of candidates for the upcoming election, actresses, singers and other sundry characters (mostly unsavoury), is uninspiring.

People yearn for technocrats, people with knowledge and skills, to come in and clean the house (similar to Plato’s ideal of a Philosopher King); but how can this be achieved?

Is the solution ‘qualifying criteria’ for politicians? The problem with electoral democracy is that such a thing is not possible; it would be seen as inherently unfair. Other countries also have their share of lunatics in the fray: South Korea created a blacklist to filter unsuitable candidates, an idea that is worth exploring, but a better solution is to have a layer of technocrats below the elected politicians. Technocracy should be in charge of day-to-day administration, to advise and guide politicians as to good, workable policy, and then implement it impartially. This is an attractive idea, but is it only wishful thinking? No; and in fact, independent Ceylon did in fact have this in the form of Civil Service, a body of people famed for intellect, independence and probity.

When we refer to a civil servant, it is not a crony who owes his appointment to some political master. A civil servant should be one selected on the basis of excellent academic credentials and a rigorous entrance exam. This ensures that only bright and intelligent people are brought into the service. This is then followed by a two-year period of internship (that was called a “cadetship”), where they learn the practical aspects of administration by working alongside senior colleagues. It is only after this process that they will be fit for the real administrative work in running a country.

Thus, the people entrusted with administration will have a minimum of three years of university study and two years of practical experience even before they start real work. Note that only the best of the graduates (based on their grades) were originally selected and subjected to a further rigorous examination, so there is reasonable certainty that the basic intake is of intelligent people whose minds have been trained to think. Invested with a further two years of on-the-job training, by the end of a total process of five years, we have the basic material on which an efficient system of administration may be built.

With no entry qualifications, minimal or zero education, and only the ability to appeal to the basest of popular sentiment, the politician, unchecked, is the most dangerous creature in which to vest the reins of power.

“A civil servant should be one selected on the basis of excellent academic credentials and a rigorous entrance exam. This ensures that only bright and intelligent people are brought into the service”

Yet, electoral democracy calls for persons to be elected by popular ballot, and the field should be open to all. How can these be reconciled? The technocrat must guide the politician, advise him (or her) on the options available and check their wildest impulses. But, if this is to work, the technocrat must not be beholden to the politician. The civil service must be independent and, most importantly, politically neutral.

Independence is ensured if politicians have no say in the appointment, dismissal, promotion, transfer, pay or other matters, which must be in the hands of an independent Civil Service Commission. The service must also be politically neutral and serve governments of different political hues equally. If the service is seen as impartial, then politicians have less incentive to interfere, contributing to its independence.

Civil servants should not engage in any political activity: they must not campaign for or against any party, nor misuse state resources or power for partisan purposes; nor should they shy away from carrying out their duties when a matter is politically controversial. Politicians have democratic legitimacy, while civil servants, as unelected officials, do not. Political neutrality is necessary to bring democratic legitimacy to technocrats, the scholar mandarins who influence and implement policy.

Politicians suggest broad policies; civil servants need to advise ministers as to how these can be implemented in a workable manner. Civil servants need to examine all options: Martin Donnelly, a senior UK civil servant, stated that civil servants should avoid having to answer the question “Why wasn’t I told about this?” by disclosing all potential outcomes that might take place at the outset.

He went on to say that civil servants should also “offer some advice that is not accepted to ensure a genuine fair hearing of all options that are within a government’s political direction”. If politicians’ views are not subject to scrutiny, they may miss the opportunity to consider changing them.

Politicians generally view things on a shorter time horizon; permanent civil servants, who have to work and live with the consequences of policy in the long term, naturally take a much more longer term view. Politicians want to make the big announcement at the right time, while civil servants are more apt to take the necessary time to examine all options, resource constraints and the scale of risks, even if that means taking longer. Such a system allows collective and personal experience to be drawn and built upon, safe policy debates to occur, and experts to be brought in for shorter or longer periods.

The minister does not have unbridled power, so hasty promises made at election time cannot be implemented ad-hoc: they are refined and adjusted in keeping with the constitution, the law and practical considerations. It is through this process that promises are turned into practical policy. Often, the relationship between the two will be tense; the inexperienced and idealistic politician will demand things that sound nice but may be unfair to some citizens (people outside his particular constituency), too expensive, unsustainable or otherwise impractical.

The comedy ‘Yes Minister/Yes Prime Minister’ is based on the tension between the well-meaning but bumbling minister and the crafty permanent secretary Sir Humphrey Appleby. Although the comedy portrays Sir Humphrey as being devious, he is performing a vital function in checking and tempering the enthusiasm of the minister.

The education, training and experience of the civil servant is thus essential in tempering policy. The politician is involved only at the larger policy level, and unless there are pressing problems to be resolved, has little to do with routine administration.

Belgium ran quite successfully for a better part of two years without a proper government (i.e. politicians), and could have carried on for much longer with no serious difficulty; its administration was functioning properly under its civil service.

“Technocracy should be in charge of day-to-day administration, to advise and guide politicians as to good, workable policy, and then implement it impartially”

These ideas are far from new or radical. They were first practised by the imperial Chinese, with the first formal exams being introduced in around 605AD. This was refined and expanded over a period of 1,300 years, until 1905. These bureaucrats, the Mandarins, were the scholar officials who ran the Chinese empire, at one time the greatest in the world. This system was adopted and further refined by the British, who in turn ran their empire on these lines. It is estimated that around 120,000 people were involved in running the British Empire, although only 4,000 were directly involved. Sri Lanka today boasts 1.3 million in public service, about 500,000 of who are in the military, leaving about 800,000 to run the civil administration.

It is also the system that was used in independent Ceylon, until 1962, when short-sighted politicians facing difficulties with implementing their various hare-brained schemes decided to abolish the civil service, starting the rot that leaves citizens today wondering whether to even cast their vote at all.

An important check on the politicians was removed; so now it is irrepressible politicians who hold the reins of power.

What is needed to try and restore this system? It is very difficult, but the first step would be the creation of a completely independent Public Services Commission, which would be responsible for the appointment, transfers and
promotion of all public servants.

Ministers should no longer control the fate of public servants.

The next step would be to change mindsets: Instil the values of the civil service code through training. A basic training to instil the core values of honesty, integrity, impartiality and objectivity should be carried out throughout the service. This must be followed up by more specific work to address skills gaps.

In general, training must focus more on senior ranks, if they are to set and demand higher standards of work from juniors.

Any policy or programme is only as good as its implementation. Given the abysmal quality of politicians, even getting policies right is a problem. Working to build an independent technocracy is essential to improve policymaking and its implementation.

Recreating something that was built over a century, but destroyed within a couple of decades, will not be easy, but it’s the only way forward. Leave it to degenerate further and we will be left with a situation where it grinds to a complete halt, under its own sloth and inertia.

SL is running out of input-led ‘perspiration’ growth: Sally

Originally appeared on Daily FT

Shortages of labour, land and an ageing population mean that Sri Lanka’s opportunities for rapid catch-up growth are diminishing and institutional transformation is needed for innovation and output-led growth, a top economist has said.

The first stage of growth involves a poor country catching up with more advanced economies, using inputs like cheap labour and land, involving ‘perspiration’. 

“Once you become middle-income, especially the upper middle income categories, your growth rate inevitably slows down; this model no longer works,” said Razeen Sally, the Associate Professor of the Lew Kwan Yew School of Public Policy in Singapore.

“We are already seeing that in Sri Lanka. The population begins to age. You have less availability of labour - particularly cheap labour. Capital becomes more expensive. Wasting capital becomes more obvious, land becomes scarcer.”

Sally was speaking at an event in Colombo on ‘Asian capitalism and what it means for Sri Lanka’ organised by the Advocata Institute, a free market think tank and Echelon, a business magazine.

Inspiration vs. perspiration

When a country exhausts catch-up growth, a second stage involving innovation, which economist Paul Krugman called ‘inspiration’ or output-led growth, was needed.

“Now you have to use your brains much more, less your sweat or brawn,” Sally said.

Output-led growth requires liberal institutions and a different type of entrepreneurial capitalism.

Economists and thinkers had defined free enterprise and capitalism in different ways.

Economist Adam Smith believed that if people had freedom to produce and consume, with secure property rights, then the market economy would flourish with increased specialisation driving efficiency. 

“Specialisation goes deeper and if you do it across borders with freer trade, it goes wider.”

This was ‘Smithian’ growth. It was not about technology as such and describes the catch-up phase.

Friedrich List, a German, wrote his ‘National System of Political Economy’ against the economics of freedom of Smith. 

While Smith believed in free trade and removing state blockages to entrepreneurship, List advocated state support for business through protectionism and a variety of state interventions for young and upcoming countries like Germany to catch up with a leader like Britain.

“And that is an argument for state intervention and industrial policy, particularly to support infant industry - so-called - that has been used in countries like Japan, South Korea and Taiwan,” Sally said. “And that argument finds it echoes here in Sri Lanka.”

Marx in turn had an apocalyptic vision, that capitalism would destroy itself while Weber had an almost religious view. 

Joseph Schumpeter, an Austrian finance minister and banker who became a professor at Harvard University and one of the top economist theorists of the 20th Century, observed another pattern.

Constant change vs. equilibrium

In contrast to standard neo-classical economics which is about a stable equilibrium, Schumpeter’s economic system is highly dynamic. Capitalist economies are constantly changing. Everything is being disrupted and re-created. It is disruptive innovation which has parallels to Anichcha in Buddhism, which means impermanence. It is about constant change the central agent of which is the entrepreneur. 

“What Schumpeter’s entrepreneur basically does is beg, borrow or steal ideas and turn them into marketable, profitable products - goods and services,” Sally said.

“So you take inventions, and rarely is the inventor the innovator and turn them into innovations. An invention is a new idea. And an innovation is turning that into something for the mass market, which makes profits, which generates investment, which creates jobs and livelihoods.

“Most of the really big ideas of the past like gun powder, the printing press and algebra had come from China and the Middle East. But they were not innovated in China and the Middle East,” said Sally. 

“They were innovated in Europe by European entrepreneurs in the commercial revolution and subsequent agriculture-industrial revolutions that Europe had but China and the Middle East did not. That is a genuine puzzle.”

Creative destruction

Schumpeter talks about “perennial gales of creative destruction” which is at the heart of his capitalist economic system. 

“So capitalism is not about stable equilibrium, but about creative destruction,” Sally said. “New entrepreneurs swarm around new ideas, inventions. And they turn them into innovations at crucial junctures, in the process destroying old incumbent industries.”

IBM was disrupted by Microsoft and Apple, who will in turn be destroyed by different technologies from more nimble firms. If the system is open enough, this kind of creative destruction will happen.

“In other words we cannot have prospering capitalism without this kind of disruption, which can be socially very disruptive,” Sally said. “This can upend politics, society and indeed the world.”

In poor Asia there was room for catch up growth but the opportunities dwindle as countries become richer so they must move to Schumpeterian growth, which means improving productivity.

Schumpeterian growth

“You want to improve the efficiency of your inputs, particularly your land, labour and capital. So it is not the quantity or mass of them but the quality or efficiency.”

Malaysia, Thailand and China had an urgent need for innovation-led growth. Middle Asian countries were seeing conditions similar to Japan in the 1970s and South Korea in the 1980s, when they exhausted the catch-up period. 

The Asian re-emergence of the last century was based on imitating the West, which was fine in the catch-up phase. Sally said in the first phase, it was possible to grow with weak institutions and rule of law and even corruption.  But the changes needed to go forward does not happen automatically.

“You need to be open to international trade,” Sally said. “It is crucial. You need to improve labour markets, primary and secondary education, you need to improve hard infrastructure.

“Friedrich List would argue that you also need industrial policy. The reality is that results are mixed. Asian Tiger countries have used a combination of policies from the Adam Smith and Friedrich list textbook, but not from the Schumpeterian textbook.”

Liberal institutions and complex reforms

“But when you come to that second stage, when you really need to boost your factors of production, your overall productivity and innovation, not only do you need to get your basics right, you need to improve the quality of your institutions,” Sally says.

“You need to improve the quality of your financial system including regulations, education, skills,  better public administration, a more efficient judiciary and legal system, a tax system and bankruptcy procedures, going well beyond the basics.”

The World Bank’s Ease of Doing Business Index was a reflection of how good the business climate and institutions were. Only Singapore, Hong Kong and Korea were in the global top 10. Taiwan was 15. All are part of rich Asia. For middle and poorer Asia to join this club their institutions must be as good but Sally says improving financial systems, legal systems and educations systems is politically difficult and complicated.

“Improving institutions depends on politics,” Sally said. “So I have my doubts about Asia being successful in the future as it has in the past.” 

There was a growing belief that China’s ‘Mao and Markets’ system, where a few people at the top made decisions, may allow it to overtake the West. But doubts remained whether real innovation could take place. Sally says there were questions whether people in the top would really give up the power and rents that can be earned in an autocracy.

Sally says innovation is happening in Asia, especially in the digital space. Young people in Asia are adopting digital technologies quickly. In China, a number of tech companies were emerging. The venture capital market in China for tech was now worth $ 60 billion a year, the same as the US.

China was now promoting some state and private tech firms aggressively in a type of industrial policy. But less efficient state firms were a drag. There was also a crony private sector. Productivity growth was slowing.

Power shift

Meanwhile, the so-called Pax America which provided a relative stable geopolitical environment which allowed Asia to grow was changing, Sally said. There was a possibility of a Chinese-led ‘Pax Sinica’ emerging under different rules.

The US had maintained the peace in Asia and prevented China, India and Japan from getting into a major war with each other. After 9/11, the US became increasingly fixated on the problems in the Middle East. Obama was reluctant to intervene in Asia and Trump, a ‘gut isolationist’, is even less engaged. Another possibility was a power vacuum, which could lead to a major conflict. Meanwhile, it was not a foregone conclusion that the US would continue to pull back and a Pax Sinica will come.

Meanwhile, Sri Lanka had not initiated the major reforms required and was coming increasingly under China. Sri Lanka’s current administration had initially got the basics wrong and had to go to the IMF. It was now sticking to a broad program agreed with the IMF in getting some of the basics right.

But no major reforms had taken place in land, the banking system or education. The reform window was closing and perhaps had already closed, he said.