Revising Sri Lanka’s Competition Law Is Essential for Economic Growth

By Ashanthi Abayasekara and Yasmin Raji

As Sri Lanka’s gears itself toward a path of economic recovery, it is now more important than ever that we rethink Sri Lanka’s existing competition law framework. Why is there a need for such a framework, one might wonder, and what is wrong with the current law? 

The answer to the first, is that competition has profound implications on economic growth. In a dynamic market, competition between businesses becomes the catalyst for technological innovation, improved product quality, and increased productivity. 

For example, Advocata Institute’s newest study on the ‘Impact of Anti-Competitive Practices in the Construction Industry on Affordable Housing in Urban Sri Lanka’, highlights the prevalence of specific anti-competitive practices (such as tied selling, cross-ownerships, prevalence of monopolies, exclusive dealings and misleading advertisements) in the domestic tile, cement, and aluminum industries. These anti-competitive practices have deterred fair competition and stifled innovation among businesses, leading to increased prices of these construction goods in the market. A well-crafted and strictly enforced competition law can help minimise such effects by promoting fair competition  and the efficient allocation of scarce resources within markets. 

However, Sri Lanka’s current competition framework, the Consumer Affairs Authority Act of 2003, is far from comprehensive as it does not effectively address anti-competitive practices in markets. Here’s why.

Although the law has provisions that address abuse of dominance between businesses and anti-competitive trade practices, it fails to address issues pertaining to mergers and acquisitions, which is a fundamental aspect of competition law. Current efforts to privatise Sri Lanka’s state-owned enterprises underscore the urgency of addressing this deficiency in the current competition law to prevent the transition from government monopolies to private sector monopolies.

In addition, despite having the legislative powers, the current competition authority, the Consumer Affairs Authority (CAA), lacks the independence and institutional capacity to practically implement the above law, including successfully investigating and adjudicating anti-competitive practice cases. 

The CAA comes under the purview of a line ministry (presently the Ministry of Trade, Commerce and Food Security), with staff appointments, dismissals and decisions about remuneration being made by the minister in charge, leaving the authority susceptible to undue political influence. The CAA  relies on ministry budget allocations for its daily operations, which constrains the extent to which the authority can strengthen its institutional capacity (by hiring qualified, competent and experienced legal staff) to handle cases related to anti-competitive practices in markets, as and when needed. These financial constraints are also a major reason behind the prevalence of low salary scales for staff members. The fact that the Consumer Affairs Authority has not investigated a single case related to anti-competitive practices in the past ten years, according to findings by Verité Research, is indicative of these issues. 

The CAA also suffers from a lack of transparency, wherein their procedures and scope for carrying out raids and investigations, which are largely limited to consumer protection issues, are discretionary, making it difficult to gain the trust of the public. There is also a lack of awareness amongst the general public of the CAA and its functions. Often, this means that the public are not aware of what anti-competitive practices look like, are unaware of their consumer rights and how the CAA can help them address their concerns, resulting in very few complaints filed with the CAA. Whilst the CAA does carry out some awareness campaigns, they are mostly limited to consumer protection issues.  

To enhance the effectiveness of Sri Lanka's competition law and address anti-competitive practices, the Consumer Affairs Act of 2003 needs to be amended to include provisions on mergers and acquisitions.

Improvements to the transparency of the CAA will also be of importance to enhance legitimacy and build public trust in the organisation. One of the ways in which this can be done is by allowing public access to information on the CAA’s mandate and procedures, including actions taken by the CAA against anti-competitive practices.

In addition, awareness about the nature and consequences of anti-competitive practices should be improved amongst the public, law makers, the business community as well as the judiciary, who will be directly involved in matters related to competition.

Most importantly, establishing an independent competition authority with adequate resources is vital for the successful enforcement of competition law in the country. Some ways to do this would be to transfer the power to appoint and remove staff from the line minister to a parliamentary body. Also, revamping the CAA to serve as an appellate body for specialised regulators, like the Public Utilities Commission of Sri Lanka (PUCSL), funded through regulatory levies rather than government allocations, can contribute to its financial independence and effective enforcement.

While implementing reforms to the current competition legal framework will pose challenges, the long-term benefits of fostering a fair and competitive market far outweigh them. Such reforms are crucial for sustained economic growth and prosperity for businesses and consumers alike. Sri Lanka must pursue recommended changes without delay to secure its economic future.

#Lka70. Independent. Not free.

Photo Credit : Nazly Ahmed

By Ravi Ratnasabapathy 

Sri Lanka achieved ‘independence’ seventy years ago. What does this mean? What we achieved was self-government – the ability to elect our own rulers; but as a society did we become freer? We are no longer administered by rulers appointed from afar but is the citizenry free?

Representative, constitutional democracy is the best means known for keeping rulers accountable. Contrary to popular belief its real benefit is in removing bad leaders, not in choosing good ones.

To get elected politicians may lie or may make meaningless appeals to emotion, only a handful truly understand the problems or have real intent on solving them. Citizens have to sift truth and assess ability with minimal information. There is no way to know how a politician will perform once elected.

As a system for choosing leaders, it fares poorly but citizens can remove the really bad ones. This is the most important, maybe even the only real check that citizens have on power.

Thus while democracy is an improvement on colonialism, it does have its limits. Power remains in the hands of fallible human beings but at least the bad can be booted out. It is a good way to make a few big decisions-once elected the politician has little concern with the citizen until the next election-but it is best to leave smaller ones in the hands of citizens themselves.

What matters in daily life is personal freedom.

The Government intervenes heavily in the economy, its motives driven by corruption and the protection of special interests. They benefit a few to the detriment of the many. Fiscal prudence must be restored and cuts made to the size and scope of Government spending. This regime was elected on mandate of good governance, so they should use the mandate to restore the personal freedom of the citizenry in all spheres of life

Freedom is about not being limited by in ones actions by threats, coercion or interference of others – specifically, other individuals or institutions, such as government or religious bodies. The only good reason to interfere with people’s freedom is to prevent them doing or threatening actual harm to others.

Freedom is guaranteed by laws that restrain the power to interfere in people’s lives. The role of Government is to uphold the rule of law. As Francisco de Paula Santander (1792-1840), Colombian soldier and statesman said “Weapons have given you independence. Laws will give you freedom”.

Colonial laws

Sri Lanka has no bill of rights and we inherited some colonial laws that intrude into personal freedom.

For example, articles 365 and 365A of the Penal Code are widely considered to criminalise homosexuality and are used to arrest, detain, harass, intimidate, blackmail and shame. The Vagrant’s Ordinance is used to harass, arrest and detain sex-workers, and is also used to criminalise the poor, mentally ill, disabled and other vulnerable people. Abortion is illegal except to save the life of the mother. Half the population, women, are discriminated in the Thesawalami, Kandyan and Muslim laws.

These are questions of morals, customs and ethics, things that concern individual citizens. It is individuals who must tussle with these issues, not the law. In any case the law should apply equally to everyone, regardless of gender, race, religion or language.

We may well detest other people’s morality, religion, political views or lifestyle. We may worry that they are harming their health but these are not valid reasons to interfere in the lives of others. Minors should be protected but consenting adults should be left in peace.

Any regulation should focus on limiting public harm, not protecting morality. Strict laws on drunk driving, prohibition on sale of alcohol to minors or limiting public smoking may make sense but the recent foray of state policy, through punitive taxation and restrictive laws to stop the consumption of alcohol and tobacco is wrong.

There are licenses and taxes that most countries impose but they must be reasonable. The fact that some people disapprove of something is no reason to restrain others. The goal of taxation should be the raising of revenue, not punishment.

It is a fact that individuals disagree on things. What is the interest of one is not necessarily of the other. When one is called to give up some freedom for society what happens in reality is the sacrifice of one set of interests to another, there is no real common interest.

Self interest of politicians, officials

When the state makes laws, a choice will be made over many conflicting sets of interests-a choice in which only one side can win. The process of lawmaking is tainted by the self- interest of politicians, officials and lobbyists. It can lead to minority groups being exploited and their liberties curbed.

Therefore the passing of laws, especially those that curb rights should only be resorted to only when strictly necessary. Calls to curb or ban activities must be viewed sceptically. For example, why is horse racing banned in Sri Lanka? This may not be an important example but the problem is ‘mission-creep’ restrictions start innocuously but then keep expanding.

If freedom is to be restricted it should be up to those who want to do so to show why this is both necessary and sufficiently beneficial to warrant it. Election success does not license the winning majority to treat other people exactly as it chooses.

The philosopher John Locke listed life, liberty and property as basic freedoms: people have a right to live, to do as they please (provided they do not infringe the equal right of others) and to enjoy all that they own.

Locke’s concept of property was not limited to land, he claimed people had property in their own lives, bodies and labour. They deserved to own the things that they had spent personal effort in creating and ownership should be secure under the law.

Sri Lanka’s emergency regulations and the Prevention of Terrorism Act granted the authorities sweeping powers of search, arrest, and detention, which have led to arbitrary detention, torture, and enforced disappearances. The Government has been widely criticised for abuses against political opponents and innocents, particularly minorities who claim to have been targeted purely on suspicion.

These laws remain even nine years after the end of the war. For at least some, the right to life could be under threat. The right to property has also been under attack.

Land, houses and businesses were expropriated by law. Laws were passed limiting what property citizens could own and how they could use it. For example, land classified as paddy land can only be used for paddy, not other crops or purposes. Restrictions apply to the sale of tea, rubber and coconut land. Never mind that people may no longer want to farm or have other needs, such as housing. The colonials also confiscated land but there is no need to repeat the error.

Land reforms

Whether the exercise even benefited society is doubtful, certainly Sri Lanka never became rich as a result.

Land reforms, ostensibly to help the poor, weakened a fundamental pillar of freedom-the right to hold what we own. Once personal property is no longer sacrosanct a precedent is set for future abuse: witness the complaints of the poor evicted from their homes in Colombo or the plight of some of the displaced in the conflict zone, denied access to their land. Laws enacted to reengineer society for the betterment of the weak have created the conditions for their oppression.

Money, lawfully earned cannot be used as we wish. Exchange Controls, introduced in 1953, later expanded and later partially reversed dictate how we spend our own money. At one time it was impossible to travel abroad, spend on overseas education or buy anything imported unless deemed “essential” by the state. Thankfully some rules have been relaxed but try sending money to relatives overseas (for medical or other reasons) or remit the proceeds of property sales and we face obstacles. Are these trivial issues? Perhaps, but even so why? Colonial Ceylon had no restrictions but independent Sri Lanka does. Problems of mismanagement of finances by the Government translate to restrictions on citizens.

If citizens, even if displaced or poor, feel their rights are infringed they should be able to seek justice through the courts. Few seem to try. The system of justice has corroded. The courts exist and the police exist but are they independent enough to uphold and enforce the law? Can an ordinary person hope to win in court against a politician?

A new regime is in power, when they celebrate independence they must reflect on the state of personal freedom.

The purpose of Government should be to expand freedom, not restrict it.

New constitution

A new constitution can help protect natural justice: enshrine the due process of the legal system, ensure equal treatment; and define a personal sphere into which legislation and officialdom can never intrude.

They must recognise that people’s beliefs, lifestyle or morals vary. There is no common agreement on what is acceptable, unacceptable, tolerable or intolerable. As long as no harm is done to others the state should not intervene in such matters, legislation that permits this should be rolled back.

The independence and integrity of the system of justice must be restored.

The Government intervenes heavily in the economy, its motives driven by corruption and the protection of special interests. They benefit a few to the detriment of the many. Fiscal prudence must be restored and cuts made to the size and scope of Government spending.

This regime was elected on mandate of good governance, so they should use the mandate to restore the personal freedom of the citizenry in all spheres of life.

Ravi Ratnasabapathy is a resident fellow at the Advocata Institute.  

Dr Wignaraja: Can Sri Lanka join Asian Supply chains?

by Dr Wignaraja on Daily Mirror

President Trump’s pledge to put America first during a global trade slowdown has sparked worries that the era of export-led growth has ended. Trade in Asia and globally has slowed since the 2008 global financial crisis but it is not the end of export-led growth. The real issue, however, is whether Sri Lanka can follow East Asia’s success in global supply chains amid slower trade growth and a likely rise in protectionism. Global supply chains refer to the geographical location of stages of production (design, production, marketing and service activities) in a cost-effective manner and linked by trade in intermediate inputs and final goods. For instance, the Toyota Prius—a hybrid electric mid-size hatchback car—for the US market was designed in Japan and is largely assembled there, but some parts and components are made in Southeast Asia and China. Supply chains exist in a wide range of manufacturing and services activities.  East Asia’s shift from a poor, less developed agricultural periphery to a wealthy global factory over the last half a century is an economic miracle. The extent of the region’s participation in global supply chains is significantly greater than elsewhere and has spurred East Asia’s global rise to the coveted “Factory Asia” league with the middle-income status for many economies.  In 2015, the developing economies in East Asia accounted for 34 percent of global supply chain trade with China making up 15 percent and Southeast Asia for 7 percent. This compares with 34 percent for the European Union, 10 percent for the United States and 5 percent for Japan.  However, South Asia is a relatively small player. India accounts for 1.7 percent of global supply chain trade and the rest of South Asia, including Sri Lanka, for 0.13 percent. Structural transformation and rising wages in China have encouraged an outward shift of labour-intensive segments of supply chains ranging from clothing to electronics. Sri Lanka has the potential to attract such supply chains from China. It is strategically located on the way to Europe, offers low wages with reasonable labour productivity and has a dynamic clothing industry. Close proximity to the large Indian market, which is a magnet for Chinese outward investment, is another advantage.  Smart business strategies and market-friendly national policies have supported East Asia’s achievement in supply chains. Being a big firm naturally creates advantages to participating in supply chains due to a larger scale of production, better access to technology from abroad and the ability to spend more on marketing.  It is crucial for small and medium-sized enterprises (SMEs) to work with large firms. Hence, smart business strategies, such as mergers, acquisitions and forming business alliances with multinationals or large local business houses are all rational approaches, as is investing in domestic technological capabilities to achieve international standards of price, quality and delivery. East Asia’s experience suggests that nimble SMEs can also join supply chains by locating to industrial clusters and reap the benefits of interdependence such as co-financing a training centre or a technical consultant to upgrade skills. Business associations can facilitate clustering by mitigating trust deficits to cooperation among SMEs and by coordinating collective actions for cluster formation. For instance, major industrial clusters are visible in Viet Nam near Ha Noi and Ho Chi Minh City, where large firms are surrounded by thousands of SME suppliers and subcontractors making garments, agricultural machinery and electronics goods. Turning to national policies in East Asia, modern cost-competitive infrastructure is crucial for supply chains. This means investing in world-class ports, roads to ports, logistics, electricity supply and information technology infrastructure. Maintaining open trade and investment regimes which encourage investment and transmit price signals to business are likewise important, as well as sound financial systems which emphasize competition among commercial banks and financial inclusion. High-quality, affordable technical and marketing support services and investing in education to develop skilled labour both help SMEs join supply chains. More controversial is the use of industrial policies in East Asia to target credit and subsidies to particular sectors or firms. Some oft-cited examples of failures include Korea’s heavy and chemical industry push, Malaysia’s national car project (the Proton) and China’s home-grown 3G mobile technology TD-SCDMA. More research is needed on good practices, as there is a high risk of government failure and cronyism associated with industrial policies. Joining supply chains will boost industrialization, jobs and incomes in Sri Lanka. There is no one-size-fits-all approach for Sri Lankan firms to join supply chains. Smart business strategies, facilitating business associations and market-friendly policies are all useful ingredients, while business and government collaboration is essential to tailor these ingredients to national circumstances. (Ganeshan Wignaraja is Advisor in the Economic Research and Regional Cooperation Department of the Asian Development Bank (ADB). The views expressed here are solely the author’s own and do not represent the position of the ADB. This is a guest article for the Ceylon Chamber of Commerce ‘Trade Intelligence for the Private Sector’ (TIPS) initiative that helps its member businesses be up-to-date on new developments in international trade. For more on the subject of this article, refer Production Networks and Enterprises in East Asia an edited volume by G. Wignaraja (2016)) 

Advocata's submission for the Budget 2017

Echelon Magazine, Sri Lanka's premier business magazine published excerpts of Advocata Institute's Budget submission for 2017

THINK TANK ADVOCATA IS PROPOSING LOWER TRADE TAXES AND TRIMMING PUBLIC SECTOR EXPENDITURE IN ITS RECOMMENDATIONS FOR BUDGET 2017 PRESENTED TO THE MINISTRY OF FINANCE AND PLANNING

Summary recommendations
1. The immediate policy priority should be to restore emphasis on exports: Liberalise the trade and investment framework to attract FDI.

2. Public sector reforms to cut costs are vital. While tax increases may be unavoidable, the additional burden on the public must be minimised: Reforms for the public sector to reduce its size, cut corruption and improve efficiency are essential.

3. The current tax structure is incoherent and chaotic. It must be reviewed and policy grounded on sound fiscal and tax principles including fiscal adequacy, administrative feasibility, simplicity, transparency and stability.

Despite a significant improvement in the first half of the year, meeting Sri Lanka’s budget deficit for 2016 will be challenging. A significant amount of fiscal consolidation will still be needed over the next few years if the government is to achieve its stated goal of reducing the budget deficit to 3.5% of GDP by 2020 or indeed meet its commitments to the International Monetary Fund (IMF), which is likely to create considerable uncertainty over the likelihood of further tax increases.

Given the difficult environment and ambitious targets, the government may be tempted to resort to ad hoc, short-term measures to deal with fiscal crises as they arise, creating a volatile business environment, eroding confidence and leading to a lack of predictability in revenue targets. This, in turn, results in further ‘quick fixes’.

This is a vicious cycle that must be broken if consistency and predictability is to be restored to the tax system. This is possible if the government adopts a framework of evidence-based policymaking, and we urge that this be done as a matter of priority.

Making policy that is based on evidence is not easy, but it is possible to draw on the experience of countries such as the UK, which have adopted such an approach. Frameworks that governments can follow to build and support a system of evidence-based policymaking are available, and the government should seek specialised assistance to implement a structured approach. This will help ensure consistency and predictability in policy, improving business confidence.

Policy making must be an ongoing process, and consultation and assessment should not be limited to a period a few weeks before the budget. Poorly researched policy may cause unintended consequences and result in policy reversals. While all suggestions must be considered, many are likely to come from sectors seeking privileges. These must be carefully researched, subjected to wider consultation and adopted only if overall benefits to society outweigh costs. Some of the complexity and anomalies in the tax code may be traced to the accommodation of various special interest groups.

In achieving its fiscal targets, the government cannot limit its focus to raising taxes. Breaking from the pattern of the past, equal or even greater emphasis must be placed on the reduction of expenditure, reviewing not only the scale of spending but also the scope of the government.

An economy drive eschewing extravagance, the elimination of corruption and waste through increased transparency, and open processes must necessarily form a part of this exercise. Sri Lanka’s leaders frequently cite the example of Singapore. Fiscal prudence has been a hallmark of Singapore’s governing philosophy and successful management of the economy – an ethos that must become a watchword for Sri Lanka’s rulers. The Singapore Civil Service’s “Cut Waste Panel” and “Economy Drive” offer useful practical lessons in managing costs and could be adapted for Sri Lanka.

The tax system must be simplified, widening the base and increasing compliance. The finance minister’s commitment to this is laudable. The remainder of this submission seeks to outline a few key issues and offer avenues for the administration to explore. We believe these ideas are worthy of careful study and could yield outcomes that will assist in stimulating growth, reducing the budget deficit, and simplifying and rationalising the tax system.

RETHINK THE DEVELOPMENT STRATEGY
Restore policy emphasis on exports

Lacking a large domestic market and possessing few natural resources, exports offer the best opportunity for rapid development.

Successful integration of the manufacturing sector into global production networks has played a key role in employment generation and poverty reduction in China and other high-performing East Asian countries.

The market-oriented policy reforms of 1977/8 were based on this rationale and served the country well, resulting in a notable diversification of the commodity composition of Sri Lanka’s exports and a consistent improvement in share of world manufacturing exports until the late 1990’s.

However, protectionist pressures began to build in 2001, and from 2004, the relatively open trade policies of the past were explicitly and systematically reversed. A policy paper by the World Bank titled “Increase in Protectionism and Its Impact on Sri Lanka’s Performance in Global Markets” shows that, today, through the proliferation of a variety of para-tariffs, Sri Lanka’s tariff policies are just as protective as they had been more than 20 years earlier.

The present protectionist import tax structure has serious costs for Sri Lanka’s economic welfare and growth; Sri Lanka’s exports relative to GDP have declined, as has its share of world exports. Sri Lanka has fallen significantly behind its competitors. Vietnam, which was on par with Sri Lankan exports in 1990 with $2 billion per annum, today exports $162 billion versus Sri Lanka’s $10.5 billion.

A bulk of Vietnam’s exports is driven by foreign investment and a globally competitive agriculture sector that emerged in the wake of a liberalisation drive that moved away from ‘self-sufficiency’. FDI firms account for 71% of Vietnam’s and 44% of China’s exports. The lesson is clear: To boost growth and create productive employment, Sri Lanka should cut barriers to trade and investment, and focus on attracting export-oriented FDI.

The most important reforms needed are listed as follows:

1.Trade policy reforms: Move from the present chaotic tariff structure towards a transparent, uniform tariff structure
• Unify the existing Customs duty and the plethora of para-tariffs (PAL, VAT, CESS, Customs Surcharge) into a single Customs duty at the individual Customs code level, and then reduce Customs duties across the board to a uniform nominal rate of 15%. Moving towards a low, uniform tariff structure has the potential to increase tariff revenues. This would speed up Customs clearance and reduce the potential for corruption as it reduces the discretion of Customs officials and makes the trade regime predictable.
• On the export side, remove all cess as it reduces the effective price received by exporters, and thereby discourages exports. There is no evidence to suggest that these cesses promote local downstream processing of primary products that are now exported in ‘raw’ (unprocessed) form.
• Join the Information Technology Agreement of the WTO to create free trade in electronics, which will attract FDI to this sector.

2. Foreign direct investment reforms
• Restore the role of the Board of Investment as the ‘one-stop shop’ for investment approval/promotion (as envisaged in the BOI charter). This requires repealing the Revival of Underperforming Enterprises and Underutilized Assets Act (2011) and the Strategic Development Projects Act (2011), or passing new legislation to supersede these two acts.
• It is, of course, necessary to rationalise the fiscal incentives offered to investors, but there is a strong case for providing export-oriented foreign investors with time-bound tax holidays and investment tax allowances beyond the tax holiday period. There is evidence that tax incentives play an important role in influencing location decisions of export-oriented (efficiency-seeking) FDI, especially where competing countries still offer them, provided of course that the other preconditions are ‘reasonably’ met. (The evidence used in recent policy reports by the World Bank to argue against tax incentives comes from studies that have not made a distinction between ‘market seeking’ and ‘export-oriented’ FDI). Removing all tax incentives, while other negatives continue to weigh on the overall competitiveness in investment and trade, may be counterproductive.
• Sri Lanka has to improve property rights to draw investment. The guarantee against nationalisation of foreign assets without compensation provided under the Article 157 of the present Constitution needs to be maintained under the ongoing constitutional reforms.
• Avoid the current practice of ‘domestic value added’ [which is defined as per unit of domestic retained value (wages + profit + domestically procured intermediate inputs) as a percentage of growth output] as an evaluation criteria in approving investment projects.

The very nature of the ongoing process of global production sharing (production fragmentation) is that per unit value added of production plants located in a given country within vertically integrated global industries (such as electronics and electrical goods) is usually very thin. The contribution of such production to domestic output (GDP) depends on the volume factor and the ability to produce for the vast global market, not on per unit value added.

In some traditional industries that use diffused technology (such as garments, footwear, travel goods), there is opportunity to increase per unit value added by forging backward linkages, but this is a time-dependent process and depends on export volume expansion. In the garment industry, per unit value added was around 20% at the beginning, but is now over 60%. Backward-linked knitted textile production and other ancillary input industries (hangers, buttons, labels, packaging material) have emerged as the volume of export expanded, creating sizeable demand for such inputs.

3. Macroeconomic policy
Trade, investment and labour market reforms need to be accompanied/complemented by macroeconomic policies to regain international competitiveness of the economy. Relying solely on nominal exchange rate depreciation for this purpose is not advisable, given the massive build-up of foreign-currency denominated government debt. Also, given the increased exposure of the economy to global capital markets, large abrupt changes in the exchange rate could shatter investor confidence, triggering capital outflows.

What is required is a comprehensive policy package encompassing some exchange rate flexibility and fiscal consolidation, which requires both rationalisation of expenditure and widening of the revenue base.

The current import-substitution policy retards growth and hurts consumers.

The present policy stance and import tax structure have drawn capital, labour and land to high cost, and highly protected import substitution farming and agricultural processing activities with low or negative economic rates of return. Sri Lanka’s food prices are higher than in the region due to high tariffs imposed to achieve self-sufficiency, hurting the poor and possibly contributing to malnutrition particularly of poor children. At a time when the government is burdening people with higher taxes, it is imperative that attempts be made to reduce food costs; revising this policy could contribute significantly to lowering the cost of living.

An example of this policy is rapid growth of maize and soybean cultivation over the last 10 years. These are not traditional crops and were not cultivated on any scale prior to 1998. These are used primarily as raw materials for the production of animal feed. Subjected to heavy protective tariffs, the cost of these locally produced crops are far in excess of world prices and directly related to the high cost of local poultry products. Instead of reviewing a flawed agricultural policy, the government has reacted to high retail prices of poultry by introducing price controls.

The policy of protecting the local sugar industry has had a similar impact and should also be subjected to review. The protective policy toward wheat imports has resulted in increased retail prices of bread, despite a collapse of world wheat prices by 50% since 2013.

The above highlights just a few key issues; there are many others. The government needs to study the impact of its trade and agricultural policies on consumer prices, and review its policies to maximise benefits to society as a whole. The ill effects of poor agricultural policy are not limited to higher prices, and their unintended consequences may extend to the human-elephant conflict and the recent spread of chronic kidney disease. The review of policy needs to be holistic.

PUBLIC SECTOR REFORM

Cumulative public debt and the high budget deficit have been key drivers of macroeconomic instability in Sri Lanka. Higher government borrowing not only wreaks havoc in the government’s finances, but also crowds-out private investment by pushing up interest rates. Sri Lanka also operates a “Mega State” apparatus, with a massive public sector, unproductive/loss-making state enterprises and an oversized peacetime military that further diminishes the fiscal position.

The massive increase in public sector employees starting from about 850,000 in 2005 to around 1.27 million by 2016 also has knock-on effects on the political economy, with both major parties now having to pay homage to this large voting bloc by promising unfunded and unsustainable goodies such as salary increases and other benefits – what analysts term ‘an auction of non-existent resources’ – at each election.

While most commentators emphasize enlarging the tax net to address fiscal imbalances, Advocata believes that reducing the size and scope of the state is more pressing. While political space for reforms may be limited, public opinion is increasingly skeptical of loss-making state enterprises, which is an argument reformists in government could use.

Advocata urges policymakers to look into following avenues of reform:

Addressing the debt burden

The government’s debt/GDP ratio is 75%. Debt service costs (interest and capital) accounted for 90% of government revenue in 2014. The previous year’s debt service cost actually exceeded revenue; the ratio in 2013 was a whopping 102%. Interest cost alone amounted to 37% of government revenue in 2014.

Sri Lanka regularly runs a primary (before interest payments) budget deficit, which means recurring expenditure is being funded by debt, a situation that is clearly unsustainable. Sri Lanka’s debt ratios bear some uncomfortable parallels with those of Greece, just before the outbreak of the debt crisis.

Restructuring the debt to extend its maturity and reduce interest rates could provide some relief, but disposing of unproductive state assets and using the proceeds to reduce debt is a more permanent solution and we offer a few ideas below.

Reforming SOEs

Disposing of loss-making and unproductive state-owned enterprises (SOEs) is a way of easing the debt burden and preventing further deterioration of the fiscal position. The outstanding SOE debt to banks is at Rs757 billion, more than four times what the government spent on health services in 2015. Some SOEs have accumulated so much debt that even privatisation may not be possible. These could simply be shut down with generous severance payments to employees, which will be cheaper in the long run.

Reform of SOEs need not be limited to loss-making enterprises. SOE’s often employ significant resources in terms of labour, land and other factors of production, which could be better utilised. Conducting a comprehensive productivity study would allow the government to determine which ones to shut down, which ones to privatise and which ones could be held under ownership at a government holding company in the model of Singapore’s Temasek Holdings.

Reactivating “Dead Capital”: State-held land

The Land Reform Commission was vested with about 987,000 acres, some of which could be used for more productive purposes. Additionally, government ministries, schools and other facilities occupy prime real estate blocks in major cities like Colombo, which greatly outweighs their economic value.

As an initial step, accounting of property rents at market values would allow the government to get an accurate sense of the value of the dead capital that the government is occupying, which could be put to more productive use. The Colombo Dutch Hospital project and the clearing of the Army headquarters for commercial activity are examples of how dead capital in government-held land could be activated for more productive use. The government should draw up a Land Asset Sales Programme, an orderly and coordinated programme to dispose of surplus or underutilised land. The proceeds from these sales should be used to reduce national debt. The sales programme must be run in an open and transparent manner by an independent body free of political influence to minimise corruption.

Public-private partnerships for infrastructure

Converting existing infrastructure such as highways into Public-Private Partnerships could raise funds to pay down the loans that were used to finance them. Operational rights could be auctioned in a transparent manner to private investors. New infrastructure projects should be on the basis of a Build Own and Operate (BOO) model or Build Operate and Transfer (BOT) model, which has been used successfully all over the world to finance infrastructure projects.

Restoration of the National Procurement Agency (NPA)

The NPA was established in 2004 to streamline procurement, reduce waste and corruption, and ensure better transparency and governance by centralising procurement under an independent body. The agency was believed to have been effective, which lead to it being shut down, allegedly for political reasons, in 2007. Its operation should be revived and its independence guaranteed.

The defence budget

Spending on defence has grown from around Rs144 billion in 2009 to an estimated Rs306 billion in 2016, a massive increase in a time of peace. Due to the politically charged nature of the expenditure, this has been the ‘elephant in the room’. While acknowledging that immediate demobilisation or salary cuts are not feasible, continuous growth in defence expenditure seven years after the end of the war is something that requires questioning.

It is one of the largest items of expenditure, and discussion of this subject must no longer be avoided. Cutbacks in capital expenditure and hardware are necessary. More generally, a national plan to downsize the military should serve the long-term interest of all communities in Sri Lanka.

Voluntary retirement schemes

The state currently employs over a million people and an additional estimated 220,000 workers employed in SOEs. Some analysts put the figures much higher. In total, the public sector accounts for about 15% of the total labour force.

The public sector pensions and salaries bill for 2015 was Rs717 billion, representing 49% of government revenue. The weight of the wage and pension bill has crowded out priority expenditure in education, health and essential infrastructure, and even operational expenditure necessary to enable employees’ effective functioning. Not only do the salaries and entitlements of these workers burden the fiscal position of the government, it also mops up scarce labour from the private sector. By this account, Sri Lanka probably has the largest state sector in the world.

The dependence on excess labour also means that state agencies become reluctant to invest in new technologies or procedures in fear of backlash or simply not knowing where to allocate the labour.

Reforms in this area are not going to be easy, as the 2002 UNP government discovered to its peril. However, the current levels of state sector cadre places a massive strain on the fiscal position.

The government should commission a report on the labour requirement for the state sector. While attrition and a hiring freeze are preferred methods of cadre management, for some sectors and institutions, Voluntary Retirement Schemes (VRS) may be possible. To manage pension liabilities, a new contributory pension scheme should replace the current defined benefit scheme for any new recruits to the public service.

Reform of energy utilities

Sri Lanka’s energy utilities are a source of macroeconomic instability, and reforms to the sector are long overdue. While detailed studies for longer-term reforms must be undertaken as an interim measure, re-introducing the pricing formula for fuel and extending the formula to electricity will prevent large imbalances from building up. For the electricity sector, an immediate move to daylight saving time could reduce night peak load demand by as much as a third, with consequent reduction in thermal energy generation. In Sri Lanka, the discussion is private participation in electricity centres around fixed contract IPPs. In many other countries, however, this model is now considered outdated, the world has moved on to integrated energy markets. A study by the Pathfinder Foundation carried out in 2007 provides a useful starting point for ideas on moving to energy markets.

THE TAX SYSTEM

Recent budget statements by successive governments, including the present one, have not been in keeping with sound principles of taxation. While recognising the unique political moment in which the new administration operates and the politically expedient measures that were taken to create that political moment, continuing to ignore principles of fiscal discipline can only lead to further imbalances.

The following principles serve a guide to sound tax and fiscal policy:

Fiscal adequacy
The overarching objective should be that sources of revenue, taken as a whole, should be sufficient to meet the demands of public expenditure. Revenue should be elastic or capable of expanding or contracting annually in response to variations in public expenditure. Most crucially, any new benefit or relief measures offered must be fully funded. Government finances are in a dire state, they should not be made worse; ill-conceived proposals in the past have contributed to the structural weakness of the fiscal position.

The adoption of a medium-term budget framework to prioritise, present and manage both revenue and expenditure over a multiyear framework is desirable. It can help demonstrate the impact of current and proposed policies over the course of several years, and ultimately achieve better control over public expenditure.

Rules in the Fiscal Management (Responsibility) Act may be tightened to reinstate budget discipline, and ensure fiscal responsibility and debt sustainability.

Simplicity, administrative feasibility and transparency
Tax laws should be capable of convenient, just and effective administration. Tax codes should be easy for taxpayers to comply with and for governments to administer and enforce. It is far simpler to adjust rates to existing taxes than bring in new types of taxes.

Any changes needed to the tax code should be made with careful consideration of established practices and open hearings. Each tax in the system should be clear and plain to the taxpayer. Disguising tax burdens in complex structures to deceive the public, the preferred approach by politicians in the past, should be avoided. Simplicity will close loopholes for tax evasion, reduce the scope for corruption and minimise administrative costs.

Neutrality
By and large, taxes should neither encourage nor discourage personal or business decisions. The purpose of taxes is to raise needed revenue, not to favour or punish specific industries, activities and products. Minimising tax preferences broadens the tax base, so the government can raise sufficient revenue with lower rates.

Stability
Taxpayers deserve consistency and predictability in the tax code. Governments should avoid enacting temporary tax laws, including tax holidays, amnesties and retrospective changes. The periodic revision of taxes via gazette notifications should be avoided. Put simply, a good tax policy promotes economic growth by focusing on raising revenue in the least distortive manner possible.

Sin taxes need re-thinking

While our proposals are mostly concerned with broad issues of policy, we have made an exception for ‘sin taxes’ because of their importance to the exchequer.

‘Sinful’ items such as alcohol and tobacco have traditionally been taxed heavily and are the second-largest source of tax revenue for the state. A review of these policies could develop their effectiveness and improve collection. The present government, continuing the practices of the past, has now raised taxation to prohibitive levels. This may be counterproductive because, while high taxes do deter consumption, excess taxation may drive consumers to dangerous illicit substances, and support a thriving illegal alcohol and cigarette industry.

The link between higher taxes and substance abuse is that the use of highly hazardous home brews concocted from medicinal drugs, cosmetics and pharmaceuticals also need to be examined.

Both in Sri Lanka and even in developed countries, it is a tendency for lower income groups to consume cigarettes. In Sri Lanka, there is an additional tendency for lower income groups to consume cottage industry products and items like beedies. Further research needs to be done on the link between education and awareness as opposed to the assumption that cigarette and alcohol consumption is merely a function of affordability or a broader lifestyle/environment and an awareness issue.

High taxes on cigarettes have lead to a massive increase in the lightly taxed Beedi industry, as well as expansion in illegal cigarettes. Customs statistics indicate that beedi volumes have risen from 1.1 billion sticks in 2007 to 3.2 billion sticks in 2013, while cigarette volumes declined from 4.6 billion sticks in 2007 to 4.0 billion during the same period.

Studies carried out by the Institute of Policy Studies make a case for rethinking alcohol taxes, principally to move to a structure of taxation by volume, which will increase state revenues while modifying consumption habits.

The government needs to reconsider its policies for the taxation of both alcohol and tobacco in light of all available evidence. Recent experiences in India and Pakistan highlight the problems with outright prohibition.

On PM's economic statement: most important is to liberalize trade and investment

By Ravi Ratanasabapathy

The article first appeared on the Daily News

The Prime Minister’s statement on the economy to parliament on October 27 struck many a right note and has the ingredients to take the country to the goal of doubling per capita income by 2025.

Most important was the promise of reforms to liberalise trade and investment, to attract foreign investment and restore emphasis on exports.

It is important that the sentiments expressed in the Prime Minister’s statement must follow with practical yet bold economic policy reform. A detailed policy document has been promised and would hopefully contain the necessary implementation plans.

The rest of this brief note is aimed at understanding the policy pronouncements in the context of Sri Lanka’s political and socio-economic priorities.

Improving the business and investment climate

The statement promises a lot: simplifying the process of registering a business, getting construction permits, electricity connections and bank credit, registering property, protecting minority investors, the payment of taxes, trading across borders, the enforcement of contracts, the resolution of insolvency and reforming labour laws.

The Prime Minister’s target to bring Sri Lanka into the top 70 countries in the World Bank’s Doing Business Index by 2020 is welcome. Sri Lanka currently languishes at 110 in the index amongst 185 countries and its position has actually dropped by one place under the current administration. Policy reform to increase the ease of doing business is uncontentious and will draw broad political support from across the spectrum.

However the government must be bolder. Whilst ease of doing business has improved in the last few years, Sri Lanka can do much more to expand general economic freedom in the economy. The Fraser Institute, which publishes the annual index of economic freedom ranked Sri Lanka 111 among 160 countries. The index now ranks countries in the region like Nepal higher in terms of economic freedom than Sri Lanka with India only just behind. Beyond just looking at ease of doing business, Sri Lanka should also focus on other aspects of economic freedom including removing of outdated and arbitrary regulation, reversing recent follies such as Soviet-style price controls and truly living up to the promises of liberalising international trade and investment. In this vein, the proposed establishment of a single window for investment approval in the Prime Minister’s speech is a welcome move.

Sri Lanka can emulate, and where necessary adapt, the best practice policies from other countries such as New Zealand and Australia which rank highly in terms of economic freedom

Trade liberalisation: repeal of the Export and Import Control Act

The Government promises to repeal this archaic piece of legislation and replace it with new legislation based on that of Singapore. If implemented in the true spirit of Singapore’s legislation, this would be extremely positive.

Singapore is generally regarded as a free port and the Government only restricts the import of goods seen as posing a threat to health, security, safety and social decency. Around 99% of imports to Singapore are duty-free.

The policy statement makes reference to “a low tax regime”, the lessons from East Asia and other parts of the world is that the tariff regime needs to be low and uniform. This minimises loopholes, corruption and simplifies customs processing. A low uniform rate of duty eliminates disputes with classification and enables documents to be processed on a self-declared basis (with customs only focusing on misstatements of price and quantities) which results in faster, simpler clearing of goods.

While sentiments to keep a low tax regimes are laudable, a commitment for a low uniform tariff policy should be the goal.

State enterprise reforms and financing of infrastructure

The proposed debt/equity swaps of the Mattala Airport and the Hambantota mark an important step towards reducing the Government’s debt burden. The Government should also convert other infrastructure projects such as the highways into PPP projects by auctioning operational rights.

The statement promises investment in infrastructure in logistics to improve connectivity to global supply chains. Whilst we all welcome investments in critical infrastructure, all new projects should be implemented through public private partnerships to prevent further accumulation of public debt.

The report published by the Advocata Institute on “The State of State Enterprises in 2015” shows that the state has over 245 enterprises in its books, of which only a small number actually reported their financial position. The proposed formation of a Public Commercial Enterprise Board to manage SOEs and the creation a Public Wealth Trust, a centralised body to hold the shares in SOEs is therefore timely. Hopefully these mechanisms may prove to be the first step in imposing accepted reporting practices and better management of State enterprises. Sri Lanka can learn from Singapore’s state enterprise holding company Temasek and other experiences around the world.

Additionally, the listing of the shares of SOE’s on the Stock Exchange would also impose discipline in reporting and is something the Government should explore. Minority stakes could be offered to the public which would raise revenue to the state, allow public participation in SOE’s and broad-base the CSE; even while the majority stake is still controlled by the Government.

The recent announcements regarding the closure and amalgamation of Mihin Lanka into SriLankan Airlines is encouraging but the previously announced partial privatisation of the debt-ridden airline has not yet materialised.

The proposed Public Enterprise Commercial Board should be given a wide mandate to restructure and reform SOE’s including assessing the strategic need for such enterprises, the closure of unviable enterprises and to privatise enterprises where there’s enough commercial interest. The new structure will hopefully be just the first step on the long road to improve overall accountability and governance of these state enterprises.

It is unlikely a one size fits all solution would work for reforming all state enterprises in what would inevitably become a politically charged issue. However the public appetite for bold reform in this area is high with the realisation that the cumulative losses over the last ten years amongst the 55 strategically important enterprises amounted to Rs.636 billion.

Some areas of concern: SME’s rural agriculture

Several proposals including the one to expand SME finance through quantitative targets enforced by the Central Bank must be viewed with caution. Dirigiste lending to push bank exposure further to higher-risk sectors may boomerang on lenders, especially public sector banks, resulting in losses. Any difficulties SME’s may face with access to credit need to be examined carefully and appropriate solutions developed in consultation with financiers.

The establishment of rural modernisation boards and agricultural marketing boards will need to be examined more closely. No details are available so the exact role of these bodies is not clear but the current flawed agricultural policies have pushed up food prices for consumers. Sri Lanka’s food prices are the highest in the region and the priority should be to lower the cost of living through appropriate reforms to the sector.

Apart from a few areas of doubt the overall economic statement is broadly in the right direction and if properly implemented could boost growth and improve the welfare and prosperity of Sri Lankans. The government however has a demonstrable problem with policy inconsistency over the last few years, even amongst its own ministries and between Ministers of the same party. Whilst some diversity of opinion is expected from a coalition government, some of the policies enacted in the recent past have run counter to this and other broad policy pronouncement from the Prime Minister.

These broad ideas will hopefully pass the implementation test and we await the publication of the detailed strategy document.

The writer is a Fellow of the Advocata Institute, a fee-market think tank based in Colombo. www.advocata.org