Economic priorities for the new president

Originally published in Echelon*

By Ravi Ratnsabapathy

A new president has now taken office. How should he set about addressing the concerns of citizens? During the campaign, the candidates and their supporters announced what they plan to do if elected to office. However, most of these lack credibility as they pay no heed to the constraints in the economy.

“THERE ARE THREE SIGNIFICANT PROBLEMS; THE FISCAL/ DEBT PROBLEM, EMPLOYMENT AND PRODUCTIVITY.”

So after the celebration of victory is over the successful candidate should take a long cold shower, grab a stiff drink and become acquainted with some fundamental problems in the economy. Two months ago, former minister Milinda Moragoda helpfully provided a list of seven cold economic truths that presidential candidates must face:

1. The Sri Lankan government spends twice as much as it earns in revenue. Therefore every year, the Government borrows both domestically and internationally to meet approximately half of its expenditure.

2. It’s estimated that Sri Lanka requires only 750,000 to 800,000 government employees to provide the services needed by the public. However, the state employs over 1.5 million people. This is one of the highest public servants to population ratios in the world. Besides, to ease employment pressures, the government regularly absorbs the unemployed graduates of local universities. Further, there are now over 600,000 retired government servants, who receive pensions.

3. Ninety percent of government revenues are required to be spent on servicing the national debt.

4. Sri Lanka imports around twice as much as it exports.

5. Sri Lankan Airlines, the Ceylon Petroleum Corporation, and the Ceylon Electricity Board have become dinosaurs and represent a severe drain on public finances. If left unchecked, these inefficient and costly enterprises can potentially cause the economy to collapse. Vested interests have long dominated these institutions, and no political leader has dared to restructure or reform them.

6. Although Sri Lanka is considered to be an upper-middle-income country, two million families or nearly 40% of the population is on the Samurdhi welfare programme. A new generation of political leaders must have the courage to re-examine and modernise Sri Lanka’s welfare system.

7. Twenty five percent of the Sri Lankan workforce is employed in agriculture. Experts say that in an economy such as ours, agricultural employment should be 15%. To manage this transition, Sri Lankan leaders will have to create higher-wage job opportunities in other sectors while bringing efficiencies into the farming sector.”

This is a good summary of critical issues. There are three significant problems; the fiscal/ debt problem, employment and productivity. The main problem is that the government spends far more than it collects in taxes and covers the difference by borrowing. As a result, the debt keeps rising every year, and because we borrow to pay both the capital and the interest, it increases even faster. It is exactly like a household living on a credit card but at a bigger and scarier scale. These problems have existed for decades but have progressively worsened and have now reached a difficult-to ignore point.

“DESPITE CLAIMS TO THE CONTRARY, SRI LANKA IS NOT AN ATTRACTIVE INVESTMENT DESTINATION”

In 2018, total debt service cost was 108% of government revenue, meaning all government revenue (plus a bit more) went to service debt! On average, between 2006- 18 debt service cost was 93% of revenue. What does the government do with this money? The most substantial proportion about 42% of revenue gets spent on salaries and pensions of public servants. Interest on debt absorbs another 37%, the remainder gets spent on various other services, but loss-making state enterprises consume a chunk of it.

This, in a nutshell, is the major problem. What does this mean for policy?

1. Unless tax revenues are to rise (and who will ever vote for that?), spending must fall.

2. State sector salaries and pensions are no longer affordable. Politicians cannot promise more state sector jobs or salary increases until finances are on a sound footing. At the least, recruitment and increments may have to be frozen and the difficult question of reducing employment in the public sector faced.

3. Sri Lanka is producing graduates who expect a government job. During 2005-18, state sector employment grew from 850,000 to 1.3m, partly to “create” jobs for these graduates, adding to the debt problem.

   The average overall employability ratio of Sri Lankan university graduates is 54% according to a research paper (Nawaratne, 2012). Arts and management grads have higher rates of unemployment in the country and accounted for 76% and 36% of unemployed graduates (Kanaga Singam, 2017).

   The private sector experiences shortages of labour but complain that graduates lack skills. It is insane that the best of our students taught in our universities at public expense complete fifteen years of education but lack employable skills.

   About 55% of the graduates are from arts and management while only 28% are from science, IT and engineering. For a developing country, these ratios need to be in reverse.

   Primary and secondary education also have problems, not least a lack of school places and an excessive concentration of ‘popular’ schools in Colombo, leading to long commutes for children. Education is supposed to be free, but why do so many parents spend money on tuition? Why do many opt for private “international” schools or private tertiary/university education? These are symptoms of problems in quality and access. The broader question is: can the current system generate people for a knowledge economy?

4. If public sector jobs are not available, then the onus is on the private sector to create them, which requires new investment. Sri Lanka suffers from low savings rates (around 21% of GDP in 2017/8), meaning it does not generate the same levels of domestic capital for investment that countries with higher growth rates have. To raise the growth rate significantly implies sustaining an investment rate above 30%. For example, Singapore’s investment rate averaged 35% between 1961- 96. This shortfall in investment must be met from overseas.

Despite claims to the contrary, Sri Lanka is not an attractive investment destination, as evidenced by low FDI rates. There are many issues to solve, including policy uncertainty, regulatory problems, land and infrastructure.

In the 1990s privatisations formed an essential channel for FDI, by opening new sectors for investment, notably in telecoms. Public-private partnerships in the port (SAGT and CICT) were also a success. Before the PPP arrangements, between 1997–2000 the volume of containers handled in Colombo port averages 1.7m TEU’s. SAGT started operating in late 1999, CICT in 2013 and by 2018 volumes grew to 7m TEU’s; 66% of which was handled by the two private terminals.

Privatisations and PPP’s are no longer popular, but if an investment is needed and the state is unable to borrow what other options are open? The problem with privatisations and PPPs is that if they are not done through transparent, competitive processes outcomes may be poor. This issue needs to be faced squarely. The recent closed-door deal with the ill-fated Colombo East terminal is not the way forward: the open bid of 2016 which attracted top international shipping lines and operators including the Ports Authority of Singapore was inexplicably cancelled.

The failure to create jobs is why so many of the most talented and motivated people migrate for work. We see contradictory statements by politicians, on one side celebrating the inflow of remittances, on the other bemoaning the social costs associated with migrant labour. No one seems to ask the hard question as to why the local economy cannot create enough jobs to absorb these people.

By some estimates almost 23% of the workforce is employed abroad, if not for this, unemployment would be close to 30%. The failure is not just investment but investment in high productivity jobs that will pay the high salaries that people want. Agriculture is the most unproductive sector of the economy, absorbing 28% of the workforce but generating only 8% of GDP. Politicians promise subsidies or guaranteed prices to ‘help’ this sector but is this feasible in the light of the fiscal and debt issues?

None of these challenges are easily overcome, but unless the reality is faced, Sri Lanka may be heading for multiple crises.

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*this article was published in the November issue of the Echelon Magazine, prior to Presidential Elections.

Tilt toward China is at stake in Sri Lanka's presidential election

Originally appeared in Nikkei Asian Review

By Ravi Ratnasabapathy

Candidates' foreign policy platforms have sharply different economic consequences

Sri Lanka votes Saturday to elect a new president, yet the family names of the leading candidates are familiar. The top contenders are Gotabaya Rajapaksa, whose brother held the presidency from 2005 to 2015, and Sajith Premadasa, whose father led the country from 1989 to 1993.

In terms of foreign policy, the two candidates crudely represent a choice between the continuity of current policies under Maithripala Sirisena, who repaired strained relations with India and the West, and a return to a more China-centric policy.

Rajapaksa heralds the return to China. A former soldier who served as Secretary to the Ministry of Defence during his brother's regime, he oversaw the military strategy that resulted in the annihilation of the leadership of the Tamil Tigers and the ending of the long-running civil war in 2009.

His brother, Mahinda Rajapaksa, had got into office on the back of hostility to the West, which had underwritten a putative peace process in 2002. As a part of the peace settlement, in 2003 the U.S., EU, Japan and Norway pledged $4.5 billion in reconstruction aid, but emphasized that assistance was linked to progress in the peace process, which involved concessions to the Tamil Tigers.

In the election of 2005 Rajapaksa capitalized on public disquiet over violations of the current cease-fire and heavy foreign involvement to portray the peace deal as a sellout to the Tamil Tigers and the West. When the fighting resumed the next year, it was particularly brutal, earning the condemnation of Western nations.

Rajapaksa's foreign policy, which already viewed the West negatively, gravitated further toward countries which were less critical. Leaders such as Russia's Vladimir Putin who stood up to the West were seen as models, and China, carrying a large checkbook, was viewed as particularly useful.

Following the end of the conflict in 2009, Chinese companies became involved in infrastructure development, building ports, airports, power plants and much else. Relations with India soured over extensive Chinese involvement in what it regards as its own backyard. This is the legacy Gotabaya Rajapaksa bears.

The shock defeat of the Rajapaksa regime in 2015 by Sirisena saw a change in foreign policy. The victory was hailed as triumph of democracy and welcomed by the West and India. Relations with the West and India improved and China was effectively sidelined.

Large China-backed projects were put on hold and the government threatened to renege on Chinese contracts. Economic pressures have meant that some of these projects have now resumed but the attitude to China remains lukewarm. China itself is generally thought to view the current regime as unfriendly and welcomed an abortive constitutional coup in October 2018 that temporarily installed Mahinda Rajapaksa as prime minister.

Thanks to term and age limits placed by the new government, neither Mahinda Rajapaksa nor his son is qualified to run for president, so Gotabaya Rajapaksa, who had to give up his U.S. citizenship in order to run for office, is seen as proxy.

Mahinda Rajapaksa is likely to contest the parliamentary election due next year with a view to obtaining the now powerful office of prime minister, thus he would be influential in shaping policy in his brother's government.

In any case, both are believed to share a similar worldview. A change in regime now would lead to a foreign policy realignment more favorable to China, although for economic rather than political reasons.

Battered by war, Sri Lanka faces periodic balance of payments crises and in 2016 received a $1.5 billion bailout from the International Monetary Fund -- the fourth bailout since 2001. Election giveaways mean the current IMF program is unlikely to be completed.

A pivot to China does not necessarily mean upsetting the West. The Rajapaksas are shrewd politicians and, while critical of the West, have shied away from open confrontation, not least because several key members of the regime are either foreign citizens or have permanent residency there.

The international landscape today is also very different from the previous Rajapaksa era.

Trump's foreign policy is distrustful of U.S. allies, scornful of international institutions and indifferent, if not downright hostile, to the liberal international order. In the immediate aftermath of the war in 2009 questions over atrocities, accountability and reconciliation were dominant. Ten years on, in a new global landscape, this is no longer the case.

The Rajapaksas are likely to seek accommodation with Trump, pointing to the Isis-inspired attacks on churches in Sri Lanka to present a case for alliance against a common threat from Islamic terror. India's Narenda Modi is likely to be courted in similar terms.

A Europe distracted by Brexit may be less willing to pursue difficult questions on Sri Lanka unless some serious new problems arise.

The new foreign policy is therefore likely to be more nuanced than the previous Rajapaksa era, but China will remain the first friend. For a floundering, debt-ridden economy, China's deep pockets present a far more attractive partner than the strictures of an IMF bailout.

Cost of construction and controlled prices on cement

Originally published in Daily News

By Ravi Ratnsabapathy

Sri Lanka suffers from high construction costs which makes housing unaffordable. A study on domestic migrant workers by Caritas Sri Lanka (2013) showed that for 61% - one of the reasons to migrate was to build a house. Numerous other surveys confirm this finding.

High construction costs also present problems for businesses, particularly tourism where the cost of the building forms a large part of the initial capital outlay. Last week, an article in the Daily News reported that a top executive in a private-sector property company had stated Sri Lanka’s construction cost is at least 30% higher than of Malaysia; a country that it several times wealthier than Sri Lanka.

How can someone on a Sri Lankan salary expect to build a house paying 30% more than someone in Malaysia?

According to a report by Jones Lang LaSalle (2014): “high project development costs coupled with the high borrowing costs for housing loans have breached affordable limits and restricted the home buying prospects for Sri Lanka.

Based on our understanding from the affordability assessment, only the top-income-earning resident Sri Lankans can buy homes in Colombo. Residents with limited income are forced to opt for properties that are at least 20-25 km away from the city limits.”

This is a complex problem and the government controls the price of cement to keep costs under control, but this is obviously not working if construction costs are much lower in other countries.

There are a number of reasons for high costs including supply constraints-shortages of sand and aggregates as well as high cement costs that contribute to high costs of concrete. Then there is the high price of other materials which are high due to protective taxes including steel bars and rods (taxed at 89.66%), ceramic Tiles (taxed at 107.6%), sanitaryware (taxed at 72.4%) as well as aluminium extrusions, granite, electrical fittings and carpets,

Apart from protective taxes, the lack of scale amongst contractors, low labour productivity, outmoded methods and long delays in approvals all contribute to higher overall costs.

The impact of the taxes may be illustrated by comparison to regional prices. For example according to information collated in in September 2016, steel costed around USD 723mt in Sri Lanka but costs only USD500mt in Thailand and USD 470mt in China.

What is surprising is that even cement is higher than the region, despite the price control. How can this be? The problem is in the way the government goes about setting price controls, the Consumer Affairs Authority applies a narrow range of controlled prices on cement which vary by product and manufacturer. The prices are determined based on cost estimates for each product provided by each manufacturer.

Usually if a controlled price is set too low it results in shortages but there are no visible large scale shortages, although these are not unknown, being witnessed in 2011 and 2014. Temporary shortages of cement occur from time to time due to hoarding when traders hoard stocks, in anticipation of price revisions.

It is likely that involvement of the industry in the price setting process means that they set at a level comfortable to the industry. With set prices there is no competition among producers on price, so normal competitive forces do not function either.

Quality

Why not solve the problem of high priced local cement by simply importing cheaper cement, if it is available elsewhere? The local cement industry claims this will lead to low quality (and low cost) cement imports, something that has been experienced in the past. Cheap cement is available overseas but the possibility of substandard cement or construction work is of serious concern since the consequences will manifest long after construction is completed and carry grave consequences.

Cheap imports of cement would benefit consumers but how should quality be ensured?

The problem is that Sri Lanka lacks a comprehensive building code; essential for consumer protection and public safety. Although old regulations such as the Factories Ordinance exist these are not up to date and enforcement is weak. A Standard Code of Practice to regulate and enforce design, construction and compliance requirements is necessary.

While a uniform code is absent, a multiplicity of approvals exist: at provincial, district, Pradesheeya Sabaha, urban and municipal level. These become even more complex when central agencies such as Urban Development Authority (UDA), Sri Lanka Land Reclamation and Development Corporation and Department of Agrarian Development. This leads to overlaps of authority, conflicts of instructions, contradictory regulations and compliance loopholes.

There is a lot of red-tape but it does not improve safety.

A proper code, legally enforceable, covering all classes of buildings and including safety, structural stability and accessibility is needed. The code should be enforced by holding the building contractors and architects responsible for any failures and carry criminal and civil penalties.

Along with a code, building contractors and architects should be licensed and carry professional indemnity insurance. The objective of licensing is to ensure that work is done by people who are conversant with the standard (which should carry statutory force) and conduct their duties competently and professionally.

In the event of any failure in buildings they may lose their license to practice. This is apart from any action taken in the courts. The insurance ensures that consumers can receive compensation for shoddy work.

Specialist licenses should be necessary for more complex work including:

(a) Piling works

(b) Ground support and stabilization works

(c) Site investigation work

(d) Structural steelwork

(e) Pre-cast concrete work

(f) In-situ post-tensioning work

Underinvestment

Sri Lanka has abundant limestone deposits in the North but even ten years after the end of the conflict the cement plant in the area remains closed

Underinvestment in the sector may be attributed to a combination of the uncertainty surrounding prices and protectionism. Investment decisions are long-term and price controls; despite industry influence in setting them, does add a new level of uncertainty over future profits, deterring investment. This is particularly so in the cement industry because the start-up costs are high and the gestation period for a plant is long.

In 2013 the Government imposed a restriction on the number of cement plants that may be operated in a port limiting it to one per port. If a new factory is to be set up, priority has to be given to existing operators in the port, effectively limiting competition.

Overall construction costs

Despite price controls being imposed on cement, Sri Lanka has high costs of construction. There is no coherence in policy with different objectives are being pursued in isolation, unlike for example in the UK where the Government in partnership with industry has developed a strategy to improve the performance of the construction sector by 2025. Objectives include lowering costs: a 33% reduction in the initial construction of new build and the whole-life costs of built assets, a 50% reduction in the overall time, from inception to completion of construction and a 50% reduction in greenhouse gases.

Overall, intervention in the construction market has resulted in raising, rather than lowering construction costs.

Further, by failing to understand the proper role of the state and intervening unnecessarily in setting prices it has neglected its core responsibility – regulation to protect consumers. Although in most circumstances the best protection is the common sense of an individual consumer, in instances where technical knowledge is needed to detect poor quality there is a case for regulation, particularly if public safety is involved.

The lack of a building code is a serious failure on the part of the state.

To protect consumers the Government should stop regulating the price of cement and focus on drawing up and enforcing a proper building code.

To lower costs the tax structure on construction materials must rationalised and competition facilitated.

Dysfunctional Taxation

Originally published in Echelon

Much of Sri Lanka’s money problems can be traced to its weak income tax.

By Ravi Ratnasabapathy

It may seem paradoxical; the idea that higher taxes will spur economic growth. The theory goes that high taxes are a drag on growth by taking away resources from people and companies that can otherwise be productively deployed. However, in poor and middle- income countries, where tax collections relative to the size of the economy is low, the opposite is often true. Taxes help pay for critical infrastructure and social services; without roads, schools and hospitals, private sector wouldn’t invest.

Poor countries struggle to raise adequate tax revenue to pay for public infrastructure. This is the cost of being poor; most people are penniless, and much of the economic activity is in the informal sector, which puts it beyond the taxman’s reach.

Businesses and wealthy people who should pay tax on profit or income don’t feel compelled to do so because the government is usually corrupt, infrastructure derelict and nobody else is paying taxes anyway. Income tax that businesses and self-employed pay on their profit, and those with jobs pay on their income is relatively easy to dodge. Although tax dodging, also called evasion, is a criminal offense gathering evidence to prove this is impossible where cash transactions are the norm, and companies don’t keep detailed records.

The other primary tax source is consumption. A country with enough resources invested in the administration can successfully enforce consumption tax by requesting companies pay a portion of turnover as tax. Enforcement is easy because it’s a simple, efficient and difficult to evade tax.

Since, consumption tax has evolved into taxing just the value addition at a higher rate than the entire turnover at a relatively low rate. Poor countries, on average, collect the equivalent of 13% of GDP in taxes. In the rich world, this number is around 34%. Middle-income countries have tax collections that fall in between those collected in the poor and the rich.

Sri Lanka is not a poor country. In fact, in 2019, when per capita GDP crossed the $4,000 threshold, it was classified as an upper-middle-income country. It rose above abject poverty ranks following the economy’s opening to market forces in the late nineteen seventies.

During the years between 1950 to 1989, the government’s tax take averaged 21 percent collected in income tax, turnover tax and import levies, combined. (see Chart 1) Sri Lanka’s total tax income as a percentage of GDP has since fallen to 11.9% in 2018, lagging behind all its developing country peers in taxto- GDP: Georgia 24%, Samoa 23%, Ukraine 18%, Armenia 17.5% and Tunisia 21%, according to IMF data.

Tax collections as a percentage of GDP now are lower than those of even sub-Saharan Africa. The Center for Tax and Development estimated three years ago that the average tax take in sub-Saharan Africa rose from 12% of GDP in 1990 to 15.1% by 2018. The turnaround in sub-Saharan Africa is due to the implementation of value-added tax, and the creation of autonomous tax agencies. Sri Lanka’s main challenge is that at the equivalent of 2% of GDP, the income tax contribution to revenue is low. The government had set a goal in its medium-term economic plan to increase income tax contribution to total tax revenue from 20% to at least 40%. Income tax is paid by companies on profits, and individuals on their earnings.

However, in 2018, three years after that announcement, income tax-to-GDP stood at 2.1 percent. This is also a much lower rate of collection than Sri Lanka’s peers in the middle-income group: Georgia and Mongolia have 9%, Bhutan 7.7%, Samoa 5.6% and even troubled Egypt has 6%. If the income tax to consumption tax ratio is to improve from  regarded as a comfortable level for equitable growth, income tax-to GDP-must reach at least 6% assuming no taxes and rates are changed.

A tax-paying population will keep governments honest, since taxpayers will want to see that their money is not squandered or worse, stolen. Even the United Nations’ Millennium Development goals included an aspiration for all countries to at least raise tax income equivalent to 20% of GDP. Mick Moor, who is the founding Chief Executive of the International Centre for Tax and Development (ICTD) of UK, identified five factors that have led to the quarter-century-long revenue decline in Sri Lanka.

Some of the problems are clear. Income tax evasion here is widespread for an economy in Sri Lanka’s state of development, the tax code has too many loopholes making it easy to avoid taxes (which isn’t an offence), Sri Lanka’s revenue department not being an autonomous agency, and broadly because governments have failed to adapt to significant changes in economic structure, by modernising the revenue system.

Moor, who published “The Political Economy of Long-Term Revenue Decline in Sri Lanka” in 2017, makes five main arguments. The first is the declining electoral pressure of large scale public spending on welfare.

Sri Lankan governments from the 1940s to 1970s undertook large scale spending on social welfare. Unusually high human development indicators were a result of mass state supply of health, education and subsidised food.

However, since the revenue was high during those decades, it was possible to sustain a ratio of government spending to government revenue of over 1.3 to 1.7 times, without too many adverse implications. (see Chart 2)

Tight budget deficit management has been a feature since the present government took office. As a result, the ratio of government spending to income has declined in the four years to 2018 to 1.4 times. By containing costs, domestic taxes now cover all recurrent expenses, excluding interest payments. The trend is impressive because its a feat previously only achieved a few times, since independence.

However, so far, it has not managed to improve overall revenue. Income tax revenue, the weakest component of the tax structure are rising, although, in the overall revenue, they are still too small to show an impact. Income taxes accounted for 18 percent of total revenue during the January – April 2019 period, after Value Added Tax, which contributed 27 percent and excise duty, which brought in 22 percent.

Total revenue from income tax increased by 9.6 percent to 104 billion rupees in the first four months of 2019, from a year ago, with revenue generated from corporate and non-corporate income tax up 10.2 percent to Rs43 billion. Revenue generated from Pay-As-You-Earn (PAYE) tax increased by 18.6 percent to Rs22.4 billion in the eight months to August 2017 from a year ago. This was because employee incomes rose and tax administration became more efficient, according to the finance ministry’s Fiscal Management Report – 2018.

The second reason for the declining revenue; is the availability of easy foreign aid. Following the 1977 general election aid flows increased rapidly. Suddenly governments were able to, without much pressure, run much larger budget deficits. During the 1970s and 80s, the demand and prices for Sri Lanka’s commodity exports began to decline impacting tax collections. Export taxes, now anathema, were a source of government revenue then. During the five years to 1975 export taxes contributed 11%, and in the five years to 1980, 23% of annual government revenue. By the late nineteen eighties, import taxes had all been eliminated.

Tax exemptions for foreign and local investments are the third factor in the steep tax revenue decline. By 1982 the Greater Colombo Economic Commission, the precursor to the Board of Investment, had both the authority to grant tax holidays, and took over the power of Customs in the management of the Export Processing Zones. Foreign investors, besides, received generous depreciation allowances and duty-free permits, for all investors and not just for those producing for export. Sri Lanka’s policy of the President holding also the job of the Finance Minister eroded the urgency for focusing on revenue, and adapting the tax department to significant changes in the economic structure. Except for 29 months between December 2001 and April 2004, when the government and the executive were from two parties, the president has also held office as Finance Minister.

Mick Moor suggests there is strong evidence that the absence of a powerful minister of finance has undermined revenue collection. An absentee finance minister is the fourth reason for ineffective revenue performance. The fifth challenge is its high reliance on taxing imports to make up for the poor tax revenue performance. Import duties have long been a significant source of revenue, because they are easy to collect. Compared to the late 1930s, Sri Lanka remains similarly reliant on taxing imports for revenue. (see Chart 3) World over governments revenue is earned mainly by taxing income and consumption. Because of the many economic growth impairing eff ects of taxing imports, many counties do so only sparingly.

Ignored so far but in Sri Lanka are property taxes. So far property tax implementation, including land tax, at municipal council level has been crude. It’s a tax that naturally falls on those who can afford to pay, and is an efficient tax since it does not discourage productive activity. It was only the relative ease with which the plantation economy could be taxed that generated a high tax rate in the mid-twentieth century. Income tax has raised significant revenue since 1932. Self-assessment was introduced as early as 1972 and a relatively sophisticated turnover tax introduced in 1963. This was replaced by VAT in 1998. That income tax success revered after 1990.

Now they generate about a third of the revenue it should be making. Instead of serving the population around a third of revenue is consumed by an exploding bill for civil servants, and another third of revenue for pensioners. Weeks ago the government announced pay and pension hikes and thousands of new state sector jobs. More tax will not disappear into an ever more bloated bureaucracy. Th ere is also light at the end of the tunnel.

Sri Lanka’s last constitutional amendments permit only members of parliament can be appointed ministers. Th e president will not be able to hold ministerial posts in the future. A powerful minister to manage finance can ensure revenue targets are met.

Improvement in revenue administration via a cloud-based application known as RAMIS of the Inland Revenue Department also helped improve the tax collection mechanism. Its already showing results in enhancing income tax collections. If indeed income tax collections do rise because the wealthier sections are paying their share of taxes on income, property values and other wealth, the underfunded public education, health and social protection systems can be fixed. The government implemented in 2015 new revenue-raising measures with some success. Taxes are never popular, and there are no easy ways to overcome such resistance.

The Millennium Challenge Corporation Compact Addressing constraints to growth

Originally published in Daily News

By Ravi Ratnasabapathy

On April 25, 2019, the board of the MCC (Millennium Challenge Corporation) approved a Sri Lanka Compact - a five-year, US $480 million grant. The grant seeks to assist the Government to address two of the country’s binding constraints to economic growth:

1. inadequate transport logistics infrastructure and planning; and

2. lack of access to land for agriculture, the services sector, and industrial investors.

Controversy has surrounded foreign loans taken by the government, which now faces difficulty in repaying them. The MCC compact, however, is a grant, so it does not need to be repaid which is a plus.

What does the MCC Compact involve?

The idea is to stimulate growth by addressing two critical areas that are constraining it. The two areas were identified by a study conducted by the Center for International Development at Harvard University. The study which took almost a year was conducted throughout 2016 and based on “Growth Diagnostics” a methodology developed by Ricardo Hausmann, Dani Rodrik and Andrés Velasco to determine the obstacles to a country’s capacity to grow.

“The main idea is that each country may be bumping against different potential constraints but each constellation of constraints must be giving off a different collection of symptoms or signals. By using Growth Diagnostics, policymakers can develop a clearer theory of change by designing policies that can take the country out of (or workaround) its current syndrome and relax its most binding constraints.” (Harvard CID)

High levels of government spending have helped drive growth over the past decade- services comprise 62% of GDP and are dominated by government spending. Manufacturing makes up only 29% of GDP and agriculture makes up the rest. It is not feasible to rely on government spending to drive growth any longer because:

• Tax revenues are very weak (only 11.9% of GDP in 2018)

• Budget deficits are high (5.3% of GDP in 2018) and

• Debt is high (central government debt was 82.9% of GDP in 2018)

If government spending is to increase (eg: by hiring new people to the public service or embarking on infrastructure spending) it requires either increased tax revenues or increased debt. The current regime has increased taxes across the board (VAT, PAL, income tax etc.,) to try and increase government revenue. Naturally, this has proved highly unpopular. If tax revenues are not available the government can borrow and spend, but with debt levels already high this is not an option either. People must also understand that debt is not “free” money – it must be repaid-out of future taxes. In effect debt is simply taxation postponed - we can spend today but taxes must go up tomorrow to repay the debt.

Simply put, the current basis of growth, driven by public sector spending is not sustainable. Therefore new avenues of growth must be found.

A key driver of growth in successful East Asian economies was exports. It was also an important driver of Sri Lanka’s growth in the 1980s and 1990s. Exports of manufactured goods grew very rapidly, at around 20% annually between 1976 and 1984. Following the outbreak of the civil war, growth slowed drastically during the next five years, but then accelerated to an average rate of 16% between 1989 and 2000. Since then, however, growth stagnated and exports have declined in importance. As a % of GDP exports have fallen steadily from a high of 33.3% of GDP 2000 to about 12.7% of GDP in 2016.

Export growth

One of the problems to growth in exports faced by Sri Lanka is the lack of diversification. Exports grow not only because of volumes but also because new products being added to the basket. Between 2000-2015 Sri Lanka added just 7 new products (worth US$ 0.1bn) to its export basket. In contrast, Thailand added 70 new products (worth US$ 21.8bn) and Vietnam 48 (worth US$ 50.4bn).

The possibilities of exporting related products within Sri Lanka’s existing export basket seem exhausted so completely new sectors must be attracted, which is not easy.

Reinvigorating the export sector is thus a priority. Bringing in new investment (local and foreign) to export industries, particularly in new sectors can create a new path to growth. What is holding back investment? The Harvard study identified the following:

1. policy uncertainty (especially tax and tariff policy);

2. inadequate access to land; and

3. poor transportation and logistics

The most important is policy uncertainty. As the study points out:

“policy uncertainty as it relates to taxes is characterized by an accumulation of contradictory announcements from various government officials on a range of taxes, including trade-related taxes….policy uncertainty is higher in Sri Lanka than in comparator countries and that investor optimism deteriorated as contradictory statements mounted.”

Unfortunately little can be done to address the policy uncertainty (the government needs to get its act in order) but the MCC grant addresses the other two.

As per the analysis:

“The potential new industries and services that will drive Sri Lanka’s future growth need high-quality industrial land with integrated infrastructure, including access to wastewater services, stable electricity supply and the ability to move goods reasonably quickly. Currently, such a combination (i) is hard to obtain in the congested Western province, (ii) is located in areas that are not sufficiently connected to other parts of the island, a fully-functioning port or airport, or people with adequate skills, or (iii) does not yet exist.”

Specifically with respect to land:

“Consultations with the private sector reveal that transaction costs to access industrial land are very high for domestic investors and foreign investors alike, but that domestic investors are advantaged by a more intimate knowledge of the system. The inability to secure land for planned investment activities has been the most common cause of investment plans being dropped or relocated to other countries in the last several years according to continuous consultations with the private sector by CID and government teams that it has worked alongside.”

A partial solution to this would be to develop industrial zones with adequate facilities. The country currently has 12 zones but most are already filled- itself is a testament to the problem. While more industrial zones will help, it does have the limitation that growth will tend to cluster in pockets around the zones, rather than being more widely spread.

Lack of transport infrastructure

The lack of transport infrastructure-critically access to the port and airport means that the majority of industries are crowded around the Western province.

“The Western Province also hosts the major logistics centres upon which other regions of the island are currently dependent in varying degrees. Consequently, the movement of goods and people within the province is increasingly problematic, imposing mounting costs and physical limitations on growth prospects in that part of the country. This, in turn, hurts the growth prospects for other regions to the extent that these regions depend upon access to logistic centres and markets concentrated in the Western Province.”

This leads to problems of congestion, high prices and uneven development, as other parts of the country get left behind. Building transport infrastructure to link up other parts of the country is therefore important.

“Connectivity concerns are also relevant in other regions of the country. The current state of transport infrastructure generally frustrates the development of inter-regional economic activity and arguably the suitability of locating investments outside the western region and near other concentrations of the population on the island. Economic development in other regions would help reduce the constraints that congestion (as it affects travel time costs, labour availability, and access to land) imposes upon growth in the western region as well as promote more inclusive and geographically widespread growth.”

It is also important to try and ease the congestion within the Western province by the efficient provision of public transport and improved traffic management. “Problems associated with congestion are expected to worsen with a high degree of certainty. Daily average road speeds in Sri Lanka (Colombo District) are estimated to decrease from 26 km/hour to 19 km/hour (22 km/hour to 14 km/hour) between 2011 and 2031. Peak hour speeds are forecast to be as low as 11 km/hour and 9 km/hour in Sri Lanka and Colombo District, respectively.”

The concept of evidence-based policymaking is unknown in Sri Lanka. Interventions are made overnight by politicians succumbing to pressure from special interest groups or their own whims and fancies. The MCC Compact is a result of careful analysis and addresses some important issues. The detailed studies on which it is based are available on the Harvard CID and MCC websites. It would be a pity if this were to fall victim to uninformed fear-mongering and petty politics.

Countering The Threats To Sri Lanka’s Democracy

Originally published by Echelon; reappeared in FNF South Asia

By Ravi Ratnasabapathy

Can There Be Democracy Without Democrats?

Democracy is an unusual form of government. Throughout much of history, humanity has been ruled by monarchs or warlords who reigned through the power of the sword. It is the only system of government where citizens are actively involved in their own governance; they do not just passively accept the dicta of a ruler. The system rests on some counter-intuitive assumptions: that a government will choose not to use its power to stay in control; that politicians and officials accept that they don’t have a right to rule – only that they may temporarily exercise authority on behalf of people.

This conflict with the instinctive desire to hold and perpetuate power probably explains its rarity; the Democracy Index rates only 20 countries (of 167) as ‘Full Democracies’ (a further 55, including Sri Lanka, are classified as ‘Flawed Democracies’). This is also why it is inherently fragile.

History has demonstrated that, without constant vigilance, it is easily overwhelmed. Almost exactly a century ago, in 1919, amid much hope, Germany became a republic, adopting a liberal constitution. But by 1933, as a result of political intrigue surrounding Germany’s ageing conservative president, Paul von Hindenburg, Hitler was appointed as Reich chancellor, legally and constitutionally.

“Many people in Germany thought that Hitler would be a typical head of government. Some, like the conservative politician Franz von Papen and the leaders of the German National People’s Party thought that they’d be able to control him because they were more experienced and formed the majority in the coalition government that Hitler headed. Others thought that the responsibilities of the office would tame and steer him in a more conventional direction. They were all wrong.

Hitler won mass support between 1928 and 1930 because a major economic crisis had driven Germany into a deep depression: banks crashed, businesses folded, and millions lost their jobs. Hitler offered voters a vision of a better future, one he contrasted with the policies of the parties that had plunged the country into crisis in the first place. The poorest people in Germany voted for his opponents, notably the Communist Party and the moderate left-wing Social Democrats, but the lower-middle classes, the bourgeoisie, the unorganised workers, rural masses and older traditionalists—Protestants and evangelicals who wanted a moral restoration of the nation— switched their votes from the mainstream centrist and right-wing parties (save for the Catholic Center Party) and gave them to Hitler instead.” (A Warning from History, The Nation)

“Sri Lanka has been independent for 70 years but spend over 30 of them in conflict ”

The world faces similar threats today, a new wave of populists is rising through democracies and threatening its foundations: in Hungary (Orban), Brazil (Bolsonaro) and the Philippines (Duterte).

Democracy is not a spectator sport. At a minimum, it needs a widely diffused will among the people to make it succeed. This may be why it is so difficult to transplant. A population with little previous experience in the process may not learn the skills fast enough to make it work in the chaotic aftermath of a revolution, as evidenced by the Arab Spring.

Sri Lankans have long experience with democracy and value the concept. A recent survey by CPA (Values and Attitudes Survey on 70 Years’ of Independence in Sri Lanka) indicated that 74% of Sri Lankans preferred democracy to any other kind of government.

The adverse public reaction to the abortive coup of October 2018, despite the unpopularity of the ruling coalition, was remarkable and probably contributed to its ultimate failure.

Yet, while support for democracy is strong, its more arcane aspects may not be as well understood; a lacuna that has been exploited to undermine the system from within.

Constitutional changes in 1972 and 1978 eroded personal freedoms but were carried out by popular, elected governments. Some changes should never have passed, but did. For example, both constitutions expressly precluded the judicial review of enacted legislation and limited it to judicial review of Parliamentary Bills (within a limited period). Was the danger of removing this important check on executive power lost on the electorate? Is the urgency of restoring this understood?

More recently, the unconstitutional dissolution of parliament and the call for fresh elections to resolve the October crisis was an attempt to subvert ostensibly democratic procedures to legitimise the unconstitutional. The ploy may well have succeeded, if not for the intervention of the Supreme Court.

These events should impress upon Sri Lankans that we cannot take democracy for granted. Its foundations, under attack since independence, are frail. Sections of the population have already called for an economic dictator. Could it end by voting democracy away?

The call from history resonates:
“‘We are living in economic chaos, and we cannot get out of it except under some kind of dictatorial leadership” (“Socialism and the Problems of Democratic Parliamentarianism”, quoted by Hayek in the Road to Serfdom).

“The problem is that economies are complex, reaching agreement on a plan becomes difficult so… the conviction grows that if efficient planning is to be done, the direction must be ‘taken out of politics’ and placed in the hands of experts” (F A Hayek, The Road to Serfdom).

And in turn:
“Planning leads to dictatorship because dictatorship is the most effective instrument of coercion and the enforcement of ideals, and as such essential, if central planning on a large scale is to be possible…… There is no justification for the belief that so long as power is conferred by democratic procedure, it cannot be arbitrary; the contrast suggested by this statement is altogether false: it is not the source but the limitation of power which prevents it from being arbitrary”.

“Democracy is not a spectator sport. It needs a widely diffused will among people to succeed”

As Hayek observes:
“Hitler did not have to destroy democracy; he merely took advantage of the decay of democracy and at the critical moment obtained the support of many to whom, though they detested Hitler, he yet seemed the only man strong enough to get things done.”

If democracy is to survive in Sri Lanka, it must be sustained by an active citizenry; but to engage meaningfully requires knowledge, skills and the disposition to participate in civic life. But the habits of the mind, as well as “habits of the heart,” the dispositions that inform the democratic ethos, are not inherited but must be learned. This is the purpose of civic education.

Traditional civic education covers the themes of procedural democracy: principles, procedures, laws, good governance and the role, responsibility and rights of citizens. This alone is not enough.

The education must also cover liberal values because in practice procedural democracy, while the best available system, has a drawback: it is not a good way to resolve moral or ethical questions.  Democracy is built on majority views, but this may mean that alternative perspectives on issues that are in the minority, controversial, novel or particularly complex may be ignored. Th is is the problem of the tyranny of the masses.

“Democracy guarantees a system of government in accordance with the wishes and plans of the majority. But it cannot prevent majorities from falling victim to erroneous ideas and from adopting inappropriate policies which not only fail to realise the ends aimed at but result in a disaster” [Mises, Ludwig Von (1998a) Human Action].

Therefore, we must define democracy not merely in terms of procedures but as a mode of living founded on values: inclusiveness, pluralism, fairness, cooperation, dialogue and non-violent resolution of conflict. It is essential to transmit to younger generations a host of democratic values such as tolerance and respect for diversity, concern with the rights and welfare of others, freedom and justice.

These values are in perfect concord with the Buddhist values of Karuna, Maitri and Ahimsa. Parents may impart these values to children, but all too often their practise is restricted to family and friends. It must be extended to strangers, especially those that look, sound or live differently.

The war has ended, but the relationship between communities is still tainted by suspicion, fear, and a lack of trust. Half the population, women, face routine discrimination, harassment and violence.

Most people are comfortable interacting with people, behaviours and ideas that they are familiar with, but react with fear and apprehension when faced with the unfamiliar. Misunderstandings cause us to respond aggressively to perceived threats to the status quo or stability, even where none exist.

The recent hostility to Muslims is founded on ignorance, misunderstanding and fear. Sri Lanka has been independent for 70 years, but spent over 30 of those years in conflict. If the post-conflict era is to lead to lasting social peace, we must transform the unfamiliar into the familiar.

How should civic education take place?

It needs to be taught in schools, starting with the importance of a rules-based system. In Germany, it aims mainly to make students aware that no matter how negative the experience with democracy may be, it never justifies totalitarian ideas or behaviour, nor does it excuse violence as a way of dealing with different views.

Political education in Germany is founded on the conviction that democracy cannot be taken for granted, no matter how strong the democratic system seems to be and enshrines the following principles:

1. Prohibition of manipulation (no indoctrination)

2. The need for controversy and diversity (discussion of controversial political positions)

3. Adapted to the skills and competence level of participants, and focus on empowerment and initialising political or civic activity; not just teaching facts

It also needs to discuss current political questions and phenomena. Controversial topics must be tackled, but with a focus on arriving at common solutions for political conflicts so that people learn how to resolve differences peacefully.

Sri Lanka removed civic education from schools in the 1970s, but fortunately, it was reintroduced in 2007 for grades 10-11 and extended to grades 6-10 from 2015. The teaching guide for civics is quite encouraging - the principal areas outlined above (except gender) are included. Unfortunately, it seems limited to only classroom instruction, and there remains the question of how well it will be taught. A rote-memorisation approach will not foster critical thinking, media literacy and values are necessary.

Other aspects of the syllabus, particularly history, are a cause for concern. For example, on the contents of history textbooks, Wettimuny references Sasanka Perera.

“The legend of battles between ancient kingdoms documented in the Mahāvamsa promotes Sinhalese-Tamil antagonism and suggests ‘a long and bloody tradition’ between the two races. Thus, the reproduction of this version of the past in the Sinhala Grade 6 history syllabus is highly problematic. It claims that the Sinhalese King Dutugemunu defeated the Tamil, ‘foreign’ ruler Elara in a war to protect Buddhism, to ‘reunite the country’ and ‘liberate the country from foreign rule’. By contrast, the Tamil Grade 6 history syllabus cites Elara as a leader that ruled ‘with justice’.”

Children sitting in linguistically segregated classes who learn diametrically incompatible versions of history, which emphasise historical injustice and continuing victimisation from irreconcilable textbooks, will not be well prepared to receive lessons in tolerance in a civics class.

To have a lasting impact, it must change attitudes so it must include practical aspects, involving cultural, extra-curricular activities as well as exercises and classroom lessons. The aim is that differences in viewpoint and culture are to be cherished and appreciated rather than judged and feared.

As the Dalai Lama pointed out: “Coexistence takes effort, but we should work to make this century an era of peace and non-violence. We need a human approach to solving problems between us. We need to talk instead of fighting, engaging in meaningful dialogue based on mutual respect. Anger is rooted in having a sense of ‘us’ and ‘them’. We need instead to respect others as members of humanity like us.”

Drowning in a sea of hatred

Originally appeared in the Daily News

By Ravi Ratnasabapathy

In Singapore, we start with the irrefutable proposition that the alternative to multi-racialism… is genocide in varying degrees. – S. Rajaratnam, then Minister for Culture (1959–1965)

The flood of anti-Muslim hate speech on social media is a disturbing phenomenon. Are organised groups using social media to radicalise people and to encourage ethnoviolence?

Hate speech is a pre-requisite for violence but understanding the role it plays requires examining its psychological underpinning.

Human minds tend to stereotype - it is a convenient means of classifying information. Placing people, ideas and objects into different categories makes the world simpler and easier to understand. Survival in a jungle dictates judging everything on first impressions and stereotypes may be particularly useful in such a setting, although life in the urban jungle demands a subtler set of rules.

We may thus form unconscious beliefs about the characteristics of social group; that the French are romantic, or that the old are incompetent. These may not be particularly harmful but we may also develop prejudice—an unjustifiable negative attitude to a particular group; Indians, Chinese, Muslims.

Humans also need to feel that they are part of a group, as tribe or clan. People identify with and feel affinity for their own group but not to other groups, something social psychologists term in-group/out-group dynamics. While we tend to see members of our own group as individuals, we view those in out-groups as an undifferentiated—stereotyped—mass. When we feel threatened by perceived outsiders, we instinctively turn toward our in-group—those with whom we identify—as a survival mechanism.

Stereotypes, prejudice and in/out group dynamics form the axes of inter-communal tensions but to turn tensions to violence people must first overcome natural inhibitions and their fear of the law.

Attacking others becomes easier if they are no longer seen as human. We may hold prejudices and anger against people we view as an “outgroup” but this is more likely to turn to violence if the outgroup is seen as less than human.

This is the role of hate speech - it dehumanises.

Dehumanisation, is defined as ‘divesting people of human qualities or attributing bestial qualities to them’ such that they are ‘no longer viewed as persons with feelings, hopes and concerns but as subhuman objects’ Bandura (1996).

“Denial of the humanity of others is the step that permits killing with impunity. The universal human abhorrence of murder of members of one’s own group is overcome by treating the victims as less than human. In incitements to genocide the target groups are called disgusting animal names – Nazi propaganda called Jews “rats” or “vermin”; Rwandan Hutu hate radio referred to Tutsis as “cockroaches.” The targeted group is often likened to a “disease”, “microbes”, “infections” or a “cancer” in the body politic.”

The current campaign against Muslims consists of two strands; one dehumanises them, the second portrays them as a threat-to Buddhists, Sinhalese and Sri Lanka in general. The second strand features rumours, false or misleading news stories that are designed to stir suspicion or fear; triggering in-group responses.

While some hate speech is easily recognised, being blatantly spiteful they also include more subtle caricatures, racist slurs disguised as jokes, teasing or “edgy” comments. The latter and some of the false news were widely shared by those who were not otherwise openly racist. These work subconsciously, reinforcing or instilling prejudices and fears into the non-Muslim community.

It can be far too easy for non-Muslims to dismiss these as silly; a bad joke at worst but they all contribute to the same end. Some people who shared hate speech on social media were later seen sharing calls for calm in the aftermath of the riots, seemingly ignorant of their own part in the crisis.

The question is where is this leading?

This hatred cannot be dismissed as a passing reaction to the Easter attacks because:

1. Anger abates with time, this is expanding instead of dissipating;

2. the almost complete absence of any reference to the victims.

Normally after a disaster, such as a flood there is an outpouring of sympathy and rush to help victims. The dominant emotion in the public is one of sympathy. While there have been some efforts in this respect they have been relatively small. The actual victims; indeed even the incidents seem largely forgotten. Instead of sympathy or charity towards victims, the nation seems gripped in a virulent wave of hate.

After the riots (that created a second set of victims, who are also forgotten) the blood lust seems temporarily satiated but the hatred has not abated. Much malicious and misleading material is in circulation. Muslims encounter routine hostility and discrimination; from neighbours, in the street and even friends. This is frightening them into greater insularity.

Meanwhile some non-Muslims, especially families with children are still wrapped in their own fears of further attacks, unable to think beyond their own concerns over security.

Fear often shuts down our ability to experience empathy so the different communities are retreating into isolation and insularity within their own groups. The social fabric is in shreds, breaking down under the strain of fear and anger.

Equality, and equal safety for all humans, is dependent not only on the law, but also on the empathy everyone in a community has for each other. If this is lost and society is divided along ethnic or religious lines into fearful and mutually suspicious groups it creates a potent cocktail that can burst into flame at the slightest provocation.

This is more so since the government seems to have only a tenuous grip on law enforcement. Impunity breeds contempt for law, and emboldens thugs, who can literally get away with murder.

These create the potential for further episodes of violence. New flashpoints are building in Kurunegala and Negombo.

Does the political leadership realise that we face a prospect of intermittent, internecine ethnic violence? Do the media houses realise their contribution to this? The media are potent and pervasive communicators; false, misleading and alarmist stories are as important as hate speech in ethnoviolence.  

Putting the genie back in the bottle seems an almost impossible task and demands a strong and coherent response.

1. The Government needs to regain control of the narrative and reassure people.

2. A zero tolerance policy for those who break the law.

In the aftermath of a disaster the political leadership should have acted jointly, sending a unifying message, channeling the emotions of the population. It should have emphasized the jointly shared societal values among all communities and stressed that this was a battle between all citizens against violent extremism.

That moment has been lost but even now those central themes must inform all communications. People are frightened, so they must first be reassured:

1. That the threat from ISIS has been effectively dealt with. They must explain the extent of the threat, the measures taken and progress toward ensuring the populations safety.

2. That structures are in place to prevent future threats: to detect and prevent radicalisation.

An information vacuum permits rumours and falsehoods to flourish, exacerbating tensions. The government needs to dominate the narrative-and match it with actions.

For example, experts seem to confirm that there is little immediate threat-the security measure must reflect this. In any case the convoys, checkpoints, road closures are a throwback to the LTTE and has little relevance today.  When MP’s cocoon themselves behinds layers of security people will be suspicious as to whether the threat has actually abated.

Pardoning a central actor implicated in previous Islamophobic incidents sends entirely the wrong message, about the commitment to upholding the law and the rights of citizens, including tolerance of violence.

Sensationalist news reporting of police raids uncovering weapons or other suspicious items add fuel to the fire. These may simply be ordinary criminals. So far little evidence is presented to connect them to a genuine ISIS threat but the reporting creates the misleading impression of a widespread ISIS presence that instills a general fear of Muslims. These reports seemingly confirm the false narratives on social media and are equally dangerous.   

Formal action needs to be taken against media for false or misleading reporting, even censorship may be necessary given the blatant rabble rousing by certain media houses.

“The strength of a nation lies in how well you treat all your people. It’s a mark of strength when you celebrate everyone who lives alongside you. We move forward when everyone has the freedom to live their lives as they wish, to contribute to their society as they see fit, and to be the people they want to be”

— Osama Bhutta, Amnesty International's Communications Director

The leadership must quickly resume normal activities and encourage people to maintain daily routines which help shift focus away from factors that maintain fear and uncertainty.

These collective strategies are needed to calm people, preventing fear and panic spreading in the population.

The second part of the strategy is to rebuild bridges between communities.

“Islamophobia doesn’t just affect Muslims. It affects the entire city because it breaks social cohesion”

— Jaume Asens, Deputy Mayor

Barcelona suffered an attack by ISIS in 2017 but the municipal government put in place a shock plan to combat rejection and discrimination towards the Muslim community.

We need to do the same because it affects us all.

The COPE reports

Originally appeared on Echelon

By Ravi Ratnasabapathy

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

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

Excerpts from the reports are as follows:

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

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

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

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

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

PEOPLE’S BANK DUD LOAN

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

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

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

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

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

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

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

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

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

AIRPORT AND AVIATION SERVICES

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

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

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

SRI LANKA TOURISM DEVELOPMENT AUTHORITY

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

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

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

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

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

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

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

NATIONAL WATER SUPPLY AND DRAINAGE BOARD

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

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

A veil of incorporation or a shroud of secrecy?

Originally appeared on Echelon

By Ravi Ratnasabapathy

SOEs incorporates under the companies act

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

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

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

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

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

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

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

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

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

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

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

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

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Electricity Piracy

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

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

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

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At Arm’s Length?

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

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

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

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

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Unauthorised Formation Of Subsidiaries To Perform Services For The Group?

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

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

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

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

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Dud Number

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

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

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Wholesale No Transparency

REFUSAL TO SUBMIT ACCOUNTS OF SUBSIDIARIES TO AUDITORS

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

Stopping Islamophobia

Originally appeared in the Daily News

By Ravi Ratnasabapathy

The senseless attacks on Easter Sunday shook the nation and sparked a wave of anti-Muslim hysteria that is in danger of going out of control. There is a tangled jumble of emotions and causes that need to be sifted through to understand the problem. The fears arise from:

• The entirely unexpected nature of the attack (there being previously no Muslim-Christian animosity).

• The unknown nature of the threat. Since ISIS is involved apprehension that local Muslims are enmeshed in a shadowy, global terror network, with unknown objectives. The alarm that further attacks could take place – but for which no local causes or solutions can be found. Unlike the LTTE which had clear objectives and targets, there seem to be so many unknowns with this threat that people don’t know how to deal with it.

• Inability to distinguish between the terrorist and an ordinary Muslim. Anyone with a long beard or with their head covered is seen as an extremist and therefore either a terrorist or a potential terrorist. Although Tamils faced similar suspicions they were less visible; with the Muslim’s panicky people are seeing “terrorists” on every street corner.

In addition, a lack of political leadership has lead to a breakdown in confidence in the government. There is the obvious bungling; failing to act on warnings that could have prevented the attacks. Then the absence of coherent, consistent and clear messages from the government that the situation is under control has left a vacuum which has become the perfect breeding ground for rumours and mischief.

Interested parties who seek to gain political advantage have cleverly exploited the situation by adding to the fears, spreading rumours of possible attacks, unfounded allegations against the Muslims and general messages of hate.   

Irresponsible and sensationalist media reports on discoveries of knives or swords reinforce these suspicions, never mind that these are hardly the weapons of choice for mass murder.  

The centre of the problem is therefore one of trust. People feel unable to trust the Muslim community who they view as a collective threat, neither can they trust the government to protect them from this threat.

These fears are completely unfounded but remain real in the popular imagination.

The Muslim community themselves have to deal with a different but equally complex set of emotions. The overwhelming majority of the Muslim community were as shocked and as horrified by the bombings as everyone else. Many are also filled with a lingering sense of guilt and shame that the terrorists came from their community. The innocent also find it very hard to deal with the fact that they have come to be held responsible for something that they did not do and do not support. This complexity and the lack of government leadership has left the community uncertain of how to respond. They are also fearful, unable to trust the government to protect them or their property.

Naturally a tragedy on this scale will lead to a confused outpouring of passions. The government should be marshalling all these complex, sometimes conflicting emotions into one coherent response, drawing all citizens together against the common enemy.

In the absence, the mutual misunderstanding and fears are feeding into panicky response and counter-response that is breeding a spiral of mutual mistrust and hatred.

Much of Sri Lanka’s post-independence era has been marred by cyclical violence that has followed the classic pattern of escalation described by theorists.

“Conflicts have a definite tendency to escalate, i.e., to become more intense and hostile, and to develop more issues, i.e., what the parties say the conflict is about. Therefore, escalating conflicts become more difficult to manage. The process of escalation feeds on fear and defensiveness. Threat leads to counterthreat, usually with higher stakes at each go-round. Selective and distorted perception justifies a competitive and cautious approach as opposed to a trusting and cooperative one….

...competition breeds competition….Each party believes in the evil intentions of the other and the inevitability of disagreement, and therefore takes precautionary actions which signal mistrust and competitiveness (Blake, Shepard & Mouton, 1964). When the other party then responds with a counteraction, this is perceived as justifying the initial precautionary measure”(Dr Ronald Fisher)

Unless arrested forthwith, which demands firm leadership, we may be about to embark on yet another cycle. To prevent this, the first step is to reassure the public and second is to restore law and order.

Independent experts seem confident that the security forces have dismantled the IS network but the government needs to send a clear message that it has done so. This needs to come jointly from the government, the security establishment and supported by independent experts, since the government is short on credibility. People need to be reassured that there is no further immediate threat. It is only then that tensions can be defused.

Second, the public need to be able to draw the distinction between the few hundred terrorists who were involved (with a couple of thousand supporters at most) from the millions who have done nothing and don’t want to be involved with it.

The Government, the security establishment and the Muslim community need to be seen to be working together to identify and isolate the rogue elements within the community. The Muslim community leaders are already cooperating but the effort must be visible and consistent. It must be seen as a joint effort by all communities to counter rogue elements. The fight is, and needs to visibly between citizens and terrorists, not Sinhalese against Muslims. Given the tensions, in the short term avoiding the distinctions in dress (which the community leadership has endorsed) will be helpful.

The wider public needs to understand that the Muslims who follow the austere form of Islam are not any different from the evangelical Christians. Both place more emphasis on their respective holy books than the rituals and forms that characterise their mainstream cousins. Neither is inherently more dangerous than the other. It is just that the Muslim’s adopt a distinct style of dress that makes them easily identified. Fundamentalist churches have come under attack because they proselytize but their followers are indistinguishable from the rest of the population.  The fundamentalist Muslims look odd, but they are not necessarily dangerous.

Common sense alone should tell us this. In over a quarter of a century that this form of Islam has been prevalent, we had a single attack, carried out by a handful of individuals who seem to have been radicalised overseas.    

The Muslim community in needs to redouble efforts to send a clear message that want none of this. Cool heads need to bring community leaders together and work out practical programmes to rebuild trust.

There have been sporadic outbursts of violence in several areas. Reports of vigilantes who have taken it upon themselves to check identities and police localities point to breakdown in law and order that must be immediately arrested. A message of zero tolerance of vigilantism and mob rule must go forth. At the first sign of violence, curfews need to be swiftly imposed with riot police deployed if necessary. Police must be ordered to detain and if necessary, shoot anyone disturbing the peace.

In the long term, we need to bridge the social and cultural distance between the communities which must take place through education.

Combatting the Cult of ISIS

Originally appeared on Groundviews

By Ravi Ratnasabapathy

Featured image courtesy AFP

It now seems clear that the attacks on Easter Sunday were carried out by local radicals, under the aegis of foreign fundamentalists. The problem is contained in that there is little support for this group from the wider Muslim community. While those involved must be swiftly identified with and dealt with, the bigger question is how to check the spread of radicalisation?

A paper [1] by Joel Day and Scott Kleinmann offer an approach that is summarised below.

“The central problem with focusing on beliefs is the issue of variation. Simply put, if “radical” beliefs produce terrorists, then why doesn’t every Salafist or political-Islamist mosque produce terrorists? Even more complicated, why have most of those providing material support to Islamic terrorist groups shown little understanding of theology, but instead seem to be attracted to the thrill of jihadi adventurism (Venhaus 2010)”

Violent extremism is a cult, not a religion

According to the authors, treating violent extremism as a problem of religion or belief is a mistake. The process of radical, violent mobilisation shows closer links to that of a cult.

Accordingly counter strategies based on empowering moderate, liberal voices to preach inclusion and tolerance to seemingly more “extreme” mosques may not be effective, indeed even counterproductive.

“It is therefore problematic to assume that “countering narratives,” showing extremists the error of their ways, or debating theology would do anything other than produce hostility and even spur heightened aggression.”

When confronted with countering evidence, individuals may become defensive and cling on initial beliefs more strongly, driving fence-sitters towards radicalisation.

On June 12, 2016, Omar Mateen, a 29-year-old American security guard, killed 49 people and wounded 53 others in a mass shooting inside Pulse, a gay nightclub. The killer was believed to have been gay, consumed alcohol, not known in the local mosques but showed signs of identity confusion, anger, isolation, and other attributes shared with violent individuals of all sorts.

Countering a cult

To deal with a cult the focus should be on weakening the organisational ties within the movement, not on debate. In debate people tend to rely more on intuition than reason. If people are not working from ideological standpoints there is little possibility of making headway through discussion so it may make more sense to counter the networks and personal ties between individuals and terrorist groups instead.

This model maintains that since ideology fails to predict or abet terrorist violence, other social factors such as alienation, mental health, or bonds with other bad actors explains violence. It is not that ideology doesn’t matter at all, but rather that ideological pulls exist within a social context. It is the social context that counter strategies should be focusing on.

How do cults work?

Cults Create Affective Bonds Around Friendship, not Belief

Most recruits to cults and new religious movements come from those who know one or more members of the group. The personal connection between recruiter and recruited is far more persuasive than the content of the belief system as the testimony of former cult members shows:

“The way the Jesus Army worshiped was a bit odd at first … but I soon got used to it. What really attracted me was the sincerity of the people and the obvious love and bonding that they had with each other”.

Likewise, a participant in another cult reported that:

“after his first visit to the FWBO center, he thought members of the centre were crazy and decided not to go back. However, he thought about all the people he knew there, and he recalled what a great time he had with them. Subsequently he turned up for the rest of the course.”

Similarly, terror networks operate around bonds of kinship and friendship. Scott Atran found that 95% of foreign fighters who joined ISIS were recruited by friends or family. Similarly, in his study of Al Qaeda networks, Marc Sageman found that friends and family ties were involved in the recruitment of 82% of the jihadists in his study (2004, 111–112).

A vast literature finds that terrorists are not goal-seeking or strategic, but instead are motivated by a desire for friends and comradery (Abrahms 2008). It is worth recalling that 6 of the 19 September 11 hijackers were brothers (Wickman et al. 2013).

Social Connections are Deep and Meaningful

A cult is not simply a quixotic fringe group with unorthodox practices: they are a community of practice. For alienated, isolated individuals, cults create affective bonds of love and attention received from nowhere else.

The culture of jihad is more than ideology: a burgeoning literature has found that terrorist groups have cultures of practice that go far beyond doing terror. Terrorists read poetry, weep and hug, sing, eat, and have a culture that can be observed outside of the material threat they pose.

This phenomenon is the “soft power” of jihad, which pulls recruits in not with force, but with cultural appeal and interrelational ties.

Cults Thrive on Intensive Interaction Between Recruits and Elites and Forge Social Encapsulation

Cults rely on exclusive, and isolating bonding practices that forge the conditions necessary for violence. Social encapsulation inoculates the recruits from outside influence, neutralises the stigma frequently associated with participation in such groups, and masks their deviant behaviour.

Conversely, the more civil connections a group has with others, the more engaged they become in the democratic process. Cohesion and overlapping, bridging ties between communities can prevent splintering, ideological isolation, and foster mutual respect.

Cults Offer Direct Compensation and Provision of Goods in Exchange of Allegiance

People may join associations to procure goods they could not otherwise get on their own. For cults and extremist groups alike, rewards can include power, material provisions like food and shelter, as well as ego and cosmically driven outcomes. The former Saddam Hussein Baathists joined ISIS not for ideological reasons, but to procure power and goods they were otherwise denied following the US deBaathification policy.

Many foreign fighters in ISIS don’t have experience in Arabic, which indicates that the ideology cannot be very well developed. Instead, they are promised wives, adventure, and alternatives to the lives they live in the West.

Women are promised comfort, the ability to raise a family in a pure Muslim environment—the utopia is even complete with houses, clothes, and even blenders (Speckhard 2017). None of these core elements of cult-recruitment and radicalisation operate around ideology per se.

Towards a more social strategy to counter extremism

Terrorist groups, like cults, are friend and kin networks that isolate and encapsulate new members, offering various forms of compensation and affection those members could not get elsewhere. Instead of ideology, policymakers should focus on the bonds of affection between friends and kin and build campaigns that target the correct avenues of extremist radicalisation.

The first step is to be able to identify early signs of radicalisation and those best able to do so are an individual’s friends or family. However if reporting can lead to harsh government reprisals, they will be reluctant to do so.

“Community-based mosques, youth clubs, and social services should be given more resources to gain the trust of entire friendship networks. Local basketball tournaments, food-drives, open shari’a classes, and drop-in counseling sessions are civic trust-building exercises. Within these civic institutions, friends can feel safe to report warning signs because they trust the community to carefully reprimand and rehabilitate the offender and act as a social bridge to law enforcement. Mosques should be celebrated for building deep community ties, because such social fabric is far more likely to prevent radicalization than debating the finer points of shari’a law in chat rooms.”

For example, Denmark has recently employed an affective bond-based counter-extremism program that focuses on linking up would-be jihadis with mentors, learning skills, and providing avenues of hope. This actively combats the cult-like mechanisms of friendship, love, intimacy, and compensation.

Danish mothers have also established a peer network called “Sahan,” where mothers worried about a child can seek advice and counsel from others on how to intervene.

In Canada and Germany, groups have sprung up called “Hayat”—the Arabic word for love—to highlight the loving network that ISIS sympathisers actually have at home.

Second governments should not be about policing -reporting “strange ideas or behaviours.” The government needs to support vulnerable communities-job fairs, tutoring, recreation, and civic engagement to ensure people are productively engaged.

“Since religious ideology doesn’t predict violence, but rather the social conditions of groups, governments should think of CVE as simply providing good government. In essence, we guard against violence by making our societies less vulnerable to cult-like groups seeking to isolate, encapsulate, and predate on weak individuals”

Mosques should be celebrated for building deep community ties, because such social fabric is far more likely to prevent radicalisation than debating the finer points of shari’a law in chat rooms.

We should target and counter all types of “extremist violence.” The cult analogy points to the social factors that give ideology meaning, but all types of violence have social conditions that constitute actors in particular ways. Countering extremism should be conceptualised as engaging a social phenomenon, not just a set of beliefs and ideas.

As Robert Putnam has argued, the fabric of a healthy democracy is the relational bonds between citizens (Putnam 2001). Similarly, the fabric of a strategy to counter extremism is to build a social network of alternatives to the appeal of violence.

The attacks were carried out by a few individuals, with little broader support. The government, civil society and the Muslim community need to work together to defeat this.

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[1] Joel Day & Scott Kleinmann (2017) Combating the Cult of ISIS: A Social Approach to Countering Violent Extremism, The Review of Faith & International Affairs, 15:3, 14-23, DOI: 10.1080/15570274.2017.1354458

Sri Lanka’s political system: A Failure of Governance

Originally appeared on Groundviews

By Ravi Ratnasabapathy

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

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

Some examples of general weaknesses in the political system

1. The power of interest groups

2. Campaign finance

3. Weak parliament and committees

4. Citizens as shareholders

The power of interest groups

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Campaign finance creates incentives for corruption and poor governance

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

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

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

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

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

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

Weak Parliament and committees

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

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

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

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

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

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

Citizens as shareholders

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

• They have no legal standing as owners;

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

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

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

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

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

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

Conclusion: a dysfunctional state that serves political interests

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Colombo's traffic: can solving the problem of schools help?

Originally appeared on Echelon

By Ravi Ratnasabapathy

Children hit the books; adults hit the brakes. Back to school for them, back to the gridlock for everyone.

Travelling in Colombo is now a test of patience, traffic having reached an impossible level.

For motorists, disorderly flows of vehicles, people and animals make the roads a nightmare to navigate. Toxic fumes poison pedestrians and residents alike, leaving an unsightly haze visible from the city’s high-rise buildings. Travel forums for tourists include discussions on ‘rush hour in Colombo’ and ‘the best time to miss traffic’.

Even if one gets through the traffic, parking is almost as big a hassle. School vans permanently occupy some streets, while rows of trishaws hog other parking spaces. Traffic congestion imposes a variety of costs, some obvious, some hidden, on businesses and individuals. At the most basic level, increasing congestion means longer travel times for passengers and higher operating costs for vehicle operators.

University of Moratuwa civil engineering and transport expert Professor Amal S. Kumarage estimates that Sri Lanka incurs an economic loss of around Rs. 40 billion annually due to road traffic congestion and air pollution.

Solving the larger traffic problem requires a proper public transport system, but one of the most peculiar aspects of Colombo’s problem is school traffic. The world over, school traffic creates some problems, but for policymakers elsewhere school-related traffic congestion is confined to the overcrowding and blocking of streets on or near school property. The problem with Colombo is that school traffic extends from one end of the city to the other. During peak school hours, some areas of the city are impassable. The reasons peculiar to Colombo include a clustering of popular schools in central Colombo and adjacent areas, growth in student numbers over the years, and an increasing tendency for students to commute daily from outside the city to schools within the city.

Growth in school rolls within the city has far outgrown the capacity it was designed for, and excessive centralisation of economic activity around the Western province in general and the city in particular, which draws in large numbers of commuters. In 2001, the floating population was estimated to be 400,000; today, it is thought to be 1.5 million.

“Traffic congestion imposes a variety of costs, on businesses and individuals”

A century ago, colonial rulers encountered a similar problem with congestion in the city. The Housing and Town Improvement Ordinance No. 19 of 1915 was introduced to check “the uncontrolled and irregular building spread” in the city. “These regulations attempted to control the size, orientation, spacing, height and spatial arrangement of buildings to permit sufficient direct sunlight to the buildings and maximise ventilation. The chief features of the bill were its preventive and remedial measures. These were four-fold:

1. No building was to be erected unless roads existed to serve them.

2. No building was to exceed in height the width of the street on which it was situated.

3. Rooms were to be provided with sufficient space, ventilation and light.

4. Open spaces were to be provided in the rear of the buildings as a common channel of ventilation behind continuous rows of houses.

Following this, the Geddes plan of 1921 set the boundaries of the city and designed it to make it “The Garden City of the East”. The tree-lined streets (Bauddhaloka Mawatha) and the grid system of roads in Cinnamon Gardens are legacies of that plan. The Abercrombie Plan of 1948 noted the high concentration of economic, trade and port-related activities in the city and emphasised the decentralisation of the city’s activities to the suburban areas of Ragama, Homagama and Ratmalana as satellite towns. The plan included a ring road to link these towns and the shifting of central administrative functions to Ratmalana. This plan was not implemented and neither was anything else. Despite subsequent plans in 1978, 1985 and later, nothing was enforced. The city grew organically, in an increasingly unruly manner that paid no heed to infrastructure, land or even safety constraints. The most recent spate of building apartment complexes and hotels threatens to overwhelm the water, sanitation and waste disposal infrastructure, what some now term a ‘cancerous’ development. Development, but of a malignant kind, that can eventually choke and poison the city.

Can schools be one place to start fixing things?

It is absurd that people should have to send their children halfway across the country to attend school. To the author’s knowledge, school vans routinely travel from as far as Embiliptiya and Hikkaduwa. This is a colossal waste of fuel and bad for children who are giving up family time or extracurricular activities in exchange for commute time. Parents are lured into these insane commutes by another insane system: the perception that job, marriage and all future prospects are tied to the school one attends, regardless of the actual quality of education. Previously, parents aspired to send children to central colleges within their district that provided excellent facilities, education and the opportunity to enter university.

One of the aims of expanding the system of central colleges in 1943 (when 11 were established) was to check the shift of the rural population to urban areas. The colleges, modelled after Royal College with properly equipped with science labs, libraries, playgrounds, etc, catered to students within a six-mile radius. The number was expanded to 23, and by 1944, there were a total of 54, on the basis of one per electorate.

The schools had good teachers and the principals were selected on merit (by the Public Service Commission), making them immune to political pressure and enabling them to discharge their duties without fear or favour.

“The selection of teaching and other staff was done according to a pre-designed specific cadre. The all-round educational needs of the children were reckoned as the all-important factor, and more than not, the principal was consulted in the matter of appointments. Sometimes he was invited to serve on the selection board. There was also the assumption that teachers selected to central colleges had to be necessarily proficient in some extracurricular activity and be willing to assist in the afternoons at no extra remuneration” – CTM Fernando

The purpose of the Grade 5 scholarship exam was not to send even more children to schools in Colombo, but to gain admission to the closest central college. In its heyday, the quality of the products of the central colleges was not questioned, and that “all central colleges without exception served the purpose for which they were established is borne out by the fact that a vast majority of our professionals and other governmental and non-governmental executives are the products of these central colleges” (Fernando).

The decline of colleges was due to short-sighted politics. People were clamouring for more central colleges and the MPs responded by simply renaming small schools as “central colleges,” lacking the facilities and teaching staff. The politicisation of teacher selection meant appointments of central college principals were taken over by the ministry. “This new breed of politically appointed principals were often accommodated to ‘look after the duties of the principal’, as they lacked the requisite qualification and the experience, not to mention personality, to be one. When some of them lacked any competence in English, it was argued that English was not needed in the “Swabhasha system”.

Their knowledge of education and educational administration was woefully pathetic; but none dared to comment” (Fernando).

“The recent spate of building complexities can be termed a ‘cancerous’ development”

Can this system be recreated? Central colleges lack ‘cachet’, so we can never return to that and, depending on the politicians who destroyed an existing system, to recreate one is far too optimistic; but could affordable private schools, teaching in English, restore the system of education in the provinces?

If the government has no money to spend building schools, the logical step would be to allow the popular Colombo schools to build branches outstation. Several smaller ‘international’ schools such as Lyceum already have branches outstation. Initial funding could come from investors, either local or foreign, but on the basis that fees would be charged, which is the case at international schools. That parents pay heavily in ‘donations’ to get into popular schools is well known. Paying for extra tuition is widespread. Add to this the cost of paying for long distance school transport. If the right model can be found, paying proper fees for a decent education, close to home, would be an attractive option for parents and ease some of the chronic congestion in the city.

The government would need to implement proper planning regulations to check the growth of schools in congested areas while encouraging them to set up in key locations elsewhere. Perhaps the buildings and facilities of the old central colleges could be upgraded and rebranded to attract students from the area. Instead of the proposed purchase of Mi17 helicopters (apparently for use in UN missions), the government should spend this money on school infrastructure. Volunteer teachers from overseas and teacher training programmes could help fill in the gaps for teaching staff.

These are only suggestions, but policymakers need to start thinking outside the box; even dusting off colonial era plans would be an improvement.

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.

In state business, the agency problem is on steriods

Originally appeared on Echelon

By Ravi Ratnasabapathy

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

“Investors in private companies take a risk when they put money down, but it is one taken of their own volition. The investment in an SOE is by citizens who contribute involuntarily and unwittingly.”

• Patronage
  Politics in Sri Lanka is based on patronage. Ministers face pressures from constituents for jobs or favours. State sector jobs are especially prized for status and security. Politicians believe that granting jobs is a necessary condition for re-election. In general, lawmakers and ministers in Sri Lanka across party lines and ideological divides view SOEs as providing avenues to create employment.

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

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

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

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

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

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

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

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

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

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

The rationale for the Sri Lanka - Singapore FTA

Originally appeared on Echelon

By Ravi Ratnasabapathy

Small countries have small domestic markets; a focus on exports will help overcome this natural limitation.

Sri Lanka’s economic growth has been sub-optimal for decades. The standard excuse for this was the war. When it ended in 2009, there was renewed hope that the country would at last reach its potential, but this was not to be. After a brief spurt, post-war growth has reverted back to the long-term average (4%) in each of the five years over 2013-2017. This will not be any better in 2018. Post-conflict countries expect to experience a sustained “peace dividend”, but Sri Lanka’s 2009-12 boom was surprisingly limited both in scale and duration.

There are several issues in the structure of the economy, the most important of which is the lack of export growth.

Small countries have small domestic markets, and a focus on exports will help overcome this natural limitation.

Sri Lanka retreated from a policy of openness since 2000’s raising tariffs and regulatory barriers, resulting in a sharp contraction in exports as a share of GDP, which fell from a high of 33.3% to about 12.7% of GDP in 2016. Sri Lanka’s share in global exports has also declined. The country’s share in world manufacturing exports increased from 0.05% in the mid-1980s to about 0.11% in 1999, but has since declined, reverting to the level in the 1980s. In Malaysia, which has a similar population, exports are 71.5% of GDP.

THE ROLE OF FREE TRADE AGREEMENTS
The government has re-prioritised international trade as a driver of economic growth, and FTAs are a part of this process. FTAs open opportunities for Sri Lankan exporters and investors to expand their businesses into overseas markets. Imports under FTAs mean greater competition in the local market, but this is no less important as it helps to maintain and stimulate the competitiveness of local firms.

It is only constant competition that drives productivity, which is the basis of sustainable growth. To take an analogy from sports, if Sri Lanka’s cricketers focused mainly on domestic club cricket, they are unlikely to perform well in the international arena.

Apart from keeping firms efficient, competition benefits local consumers through access to an increased range of better value goods and services.

There is a cost to this, as some firms may lose out; we will come to this.

GLOBAL CHALLENGES
Sri Lanka’s already-weak export game is about to take another knock from BREXIT and Trump. Therefore, it makes sense to increase regional trade to offset the potential decline in current markets. Countries generally trade with their neighbours, except in South Asia.

Regional trade in East Asia & the Pacific makes up 50% of total trade; in Sub-saharan Africa, the figure is 22%, but in South Asia, it is only 5%. Singapore is the current chair of ASEAN and one of its most respected members. For a small country thus far ignored by ASEAN due to the conflict and inconsistent policies, the FTA provides an important signal of a policy orientation towards greater trade and investment with the region.

Greater openness brings many benefits, but there are many stakeholders with different interests, so policy needs to take into account these varying interests.

THE IMPACT OF PARA TARIFFS ON PRICES
The customs tariff, together with the para tariffs of PAL and CESS, are taxes that are imposed on imported products that are not applied to the domestic equivalent. Since foreign exporters do not change the price that they charge for the product, the domestic price of the imported product rises by the amount of the tariff. The impact of this on various stakeholders is discussed below:

Domestic producers
Domestic producers competing with equivalent imports do not have to pay para tariffs, and so have an advantage over the imported product. As the prices of imported products rise, domestic producers have the opportunity to raise their own selling prices because competing with imported products now costs more.

It is always the case that the prices of domestic products rise when tariffs are imposed on imports. If it were otherwise, it would make no sense. The very purpose of the tariff is to enable the domestic producer to sell his product at a higher price. Therefore, domestic producers gain when the government imposes a tariff on competing
imports.

Domestic 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. It is domestic consumers who pay for the protection of domestic producers, not foreign firms.

Government
The government collects tariff revenue on whatever quantity is imported, although they do not collect it on the local product. The benefit the government creates for the local producer by raising the price of imports is collected by the local producer.

There are two domestic winners (domestic producers and the government) and one domestic loser (domestic consumers) because of the imposition of a tariff.

On the face of it, there appears to be more winners than losers, but in terms of sheer numbers, consumers in any industry far exceed the number of producers (or their employees). Consumers, however, are unorganized, so their interests may end up being overlooked.

MANAGING THE DOWNSIDE
As seen above, there are losers and winners in tariffs. When tariffs are cut, local producers may lose, although the government may still gain as a greater volume may offset a reduced rate. Managing the downside is necessary; local firms will need to compete, but they may need support to improve productivity and a period of adjustment.

The draft Trade Adjustment Programme (TAP) prepared by the Ministry of Development Strategies and International Trade provides a framework to tackle problems faced by affected industries. The underlying principle is to smoothen the transition of firms and workers to new market conditions, post liberalisation.

The government needs to work closely with each sector to tackle policy and regulatory constraints, and fix missing ‘public goods’-inadequate public services, infrastructure, etc, that sap the productivity of local firms.

LIBERALISATION OF SERVICES, MOVEMENT OF PROFESSIONALS
There has been much debate over the movement of people. Various professional associations have alleged that the FTA will lead to an influx of incompetent people who will undercut professionals or provide substandard services.

These fears are misplaced. As per the Schedule of Specific Commitments (Chapter 7, Annex 7A ), the movement of persons is restricted to intra-firm transfers of specific categories, which is no different from current provisions under the BOI. The movement of professionals outside this limited sphere is closed, hence, the question does not arise.

In fact, Sri Lanka faces shortages of both unskilled and skilled workers. A survey by the Department of Census and Statistics indicates that nearly half a million vacancies exist in the private sector (excluding micro enterprises). The state sector employs far too many people, burdening taxpayers, while depriving the private sector of people, but even a drastic reduction in the size of the state may not solve the skills shortages and mismatches.

Labour scarcities have an adverse impact on growth, while shortages of skills impacts both productivity and growth. Studies have shown that the migration of people benefits both the sending country and the receiving country (van der Mensbrugghe and Roland-Holst 2009). The welfare gain for the destination country is because immigration increases the supply of labour, which raises employment, production and thus GDP (Ortega and Peri 2009).

A strong case can be made to allow specialised skilled migration to fill gaps that exist in the market. The skills of migrants will be complementary to those of existing workers, therefore, all workers experience increased productivity, which in turn, can be expected to lead to a rise in the wages of existing workers.

EXPERIENCE WITH THE FTA WITH INDIA
The discussion so far has been abstract, how do we know how the FTA will actually work?

The experience of the much-criticised FTA with India that was signed in 1999 may indicate some of the potential.

The Indian FTA is a very restrictive document: it outright excludes many major sectors in which both countries have comparative advantages – i.e. the very rationale for trade. India subjects 15 out of the top 20 Sri Lankan products to either a tariff or quota. Sri Lanka, in turn, offered additional concessions (of only 3.5%) on only 7 of India’s top 20 products, the rest being either excluded or were already tariff-free.

It was, in fact, an agreement designed to fail, entered into only as a formality.

Despite this, export volumes have grown significantly and India has become the third-largest destination for Sri Lankan exports:
“…nearly 70% of Sri Lanka’s exports go to India using FTA provisions… While India has been the largest source of imports for Sri Lanka (even before the FTA) for many years, India has acquired the position of being the third-largest destination for Sri Lankan exports – a rank achieved through the benefit of the tariff preferences in the FTA.” (Institute of Policy Studies)

The export basket has also diversified:
“If one looks at the Sri Lankan export basket destined for India before the FTA, which was dominated by agricultural products such as cloves, peppers, areca nuts, dried fruits, nutmeg, etc., exports have now (after the FTA) become more diversified. It includes boats/ships, wires and cables, glass and glassware, apparel, woven fabric, etc. In 2013, the largest Sri Lankan export to India was boats and ships.

Sri Lanka exported 505 product items to India before the FTA in 1999, the product items exported increased to 1062 by 2005, and to 2100 product items by 2012, after the implementation of the FTA. This quadrupling of the product items during 1999-2012 provides further evidence for Sri Lanka diversifying its export basket to India after the FTA came into operation in 2000.”

The impact of the FTA is not well known because it did not affect prominent export industries. The beneficiaries were firms that were working in other areas. Neil Marine is not exactly a household name, but is among South east Asia’s largest manufacturers of fiberglass boats. The North Sails Group, the world’s largest producer of sails and a sail technology leader, manufactures many of its products in Sri Lanka.

Trade only takes place to mutual benefit. Given sufficient time, the FTA with Singapore will have similarly beneficial outcomes.

Cheap footwear imports benefit ordinary Sri Lankans

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The government aims to regulate e-commerce. It shouldn't.

A version of this article appeared on  Daily News

The Sri Lankan government reportedly intends bringing legislation to regulate e-commerce businesses operating in the country. The Finance Minister was quoted as saying “They (e-commerce operators) are just operating here. Where is the regulation for that? We will make them bring money earned there back to the country.” If this were enacted it is quite likely that Uber, Agoda and Booking.com; the businesses which have earned the ire of the Tourist Hotels Association of Sri Lanka (THASL) and the Rent-A-Car Association would pull out. These associations have lobbied for regulation.

Sri Lanka’s domestic market is small and the volume of e-commerce is smaller still. For a global company the hassle of incorporating a local office, opening bank accounts and grappling with the local administration would not be worthwhile. They would almost certainly leave.

The Hotels and Rent-a- car association have not made a clear case for their position. Consumers however would be left worse off facing higher prices and more limited choice.

Tourist arrivals

The informal tourist sector is now the fastest growing segment of the market, catering to as much as 40 percent of the tourist arrivals to the country. Internet booking engines are the lifeblood of the sector; small guesthouses depend almost entirely on them to reach their clientele.

Budget tourists, who form the majority of visitors to guesthouses cannot afford the prices of star-class hotel. Close the booking engine and we close the door to the budget tourists who will head off to India or Southeast Asia spelling certain doom to the 8,000 plus small guesthouses scattered across the country. Some mid-range tourists will choose to pay the higher rates at hotels and still come but many will not.

The beauty of allowing small guesthouses to flourish is to broaden the income earning opportunities for people with a minimal investment. Householders rent out extra rooms in their own houses, with a little refurbishment; upgrading the toilets, installing hot water and perhaps airconditioning. The money earned goes direct to the hands of local families. Further, budget tourists will patronise local shops and restaurants, offering an easy path to improved living standards.

Mark P. Hampton is Senior Lecturer in Tourism Management at the University of Kent, notes that:

My own research in Indonesia, Vietnam, Thailand and Malaysia since the mid-1990s shows that as backpackers tend to consume local products (food, coffee, beer, cigarettes etc), stay in small guest houses, and use locally owned ground transport, more of their expenditure is retained in-country than in conventional mass tourism.

Economic leakages from backpacker tourism are also significantly less than for conventional (foreign-owned) tourism, since backpacker businesses are usually locally owned and profits tend to be retained within the developing country rather than flowing overseas to international hotel groups.

Traveller reviews

Depriving these people of opportunities to better themselves in order to benefit large-scale hotels seems perverse. The booking engines do charge the guest houses a fee but the bulk of what is spent by tourists is retained locally.

What about maintaining minimum standards?

In the pre-internet era there was a problem of standards. How does a visitor know what to expect? This is the origin of the star ratings in hotels, a means to indicate standard.

This is no longer a problem. Booking engines work on the basis of traveller reviews. Visitors post their ratings of the places they stay, those that receive poor ratings are less likely to be patronised. Essentially, standards are enforced by the visitors themselves which is why this model has been so successful.

Previously the hotel industry successfully lobbied for the imposition of minimum room rates and there have been recent attempts to restrict short-lets on apartments which were seen as a threat by the hotels. Now they seek to restrict the informal sector.

Hotels in Sri Lanka need to understand that tourism is a global industry; their competition is not only domestic it is regional: from Malaysia, Thailand and Indonesia. A good number of hotels in these countries offer lower rates than the average in Sri Lanka and overall travel costs are rated to be much cheaper, as comments from tourists on the popular TripAdvisor website testify:

“There is no question whatsoever that Thailand is much cheaper than Sri Lanka and with higher quality. On average, all things being equal, Thai hotels are half the price of those in Sri Lanka and there are lots to choose from especially in the low price category.” or

“Sri Lanka is a compact island offering beautiful vistas, cultural, historical and religious sites, beach and river activities, hiking . . . all year round, taking into account the weather patterns. With ten days and proper planning, you could see and do a lot. Compared to Malaysia and Thailand many of the things you might want to do are more expensive.”

Business-friendly destination

The Sunday Times reported that when a Singapore hospitality expert asked in 2014 for a package tour of Sri Lanka, the offering was similar to that she had experienced 10-15 years ago. “It was no different. I have been visiting Sri Lanka for many years and the package was the same as 10-15 years ago. Attempting to cripple the competition locally will not improve the position of Sri Lanka’s hotels regionally and will be the detriment to the wider tourism industry.

It may also be detrimental to local Tech Startup ecosystem in general as Sri Lanka will come to seen as a place with backward and uninviting regulations at a stage the country’s tech community is desperately trying to position it as a place of innovation and attract investors. Instead of lobbying for strangling regulation the lobby groups need to reexamine their value proposition and adapt. On the government’s part, it should stay out of an industry where the average regulator and legislator has minimal understanding. Cumbersome rules will reduce Sri Lanka’s attractiveness as a forward looking business-friendly destination for FDI.

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Ravi Ratnasabapathy is a Fellow of the Advocata Institute.