The Sunday Leader

Driving Global Production Sharing In Sri Lanka

  • Removal of para-tariffs, trade liberalisation, investment protection vital

by Dinesh Isuru

Australian High Commissioner to Sri Lanka Bryce Hutchesson and Prof. Prema-Chandra Athukorala

In the light of Ministry of Development Strategies and International Trade promising to present the Agency for Development (AfD) Bill to parliament, think tanks and economists lament that Sri Lanka has a long way to go in removal of para-tariffs (taxes over and above normal tariffs) and trade liberalisation to make Sri Lanka a haven for investments.

To attract Foreign Direct Investments (FDIs) for Sri Lanka, its burgeoning Indian Ocean Island economy, should cut barriers to trade and investment, top trade economist Prof. Prema-Chandra Athukorala recently said at a forum organised by Advocata Institute, a Colombo-based free market think tank.

“This would form a natural progression from garment manufacture, on which the country is now heavily reliant. Sri Lanka’s protectionist trade policy and erosion of confidence in the legal system are key factors that have discouraged investors resulting in a decline in Sri Lanka’s share in world manufacturing exports from around 2000,” he said.

Athukorala is a Professor of Economics at Australian National University and a top consultant on international trade to a host of international organisations.

The liberalisation undertaken in the late 1970’s resulted in a notable increase in manufacturing exports and a steady increase in Sri Lanka’s share in world manufacturing exports. The reforms suffered a significant setback from about the early 2000: with the imposition of para-tariffs, and a proliferation of ad-hoc duty exemptions and case-by-case duty adjustments.

Sri Lanka has a bewildering number of para-tariffs including: Ports and Airports Development Levy (PAL), the Customs Surcharge (SUR), the Commodity Export Subsidy Scheme (Cess), and the Regional Infrastructure Development Levy (RIDL).

Sri Lanka needs to continue with reforms if it is to reap the benefits of export led growth. “That is why South Asian countries have not been able to join global production sharing like East Asia. Just having cheap labour alone is not enough.”

The global economic environment is changing with production sharing (Global Production Networks- GPN’s) becoming the prime mover of cross border production and trade. GPN’s are of two types, buyer driven and producer driven.

To date, most of the Sri Lanka’s FDI is in Buyer driven GPNs where a buyer (usually a retailer) buys finished goods. Although common in industries such as garments and footwear, globally buyer driven GPN’s formed only 12 per cent of world manufacturing trade (in 2012-13), and its share is declining.

Producer driven GPNs are where an end producer assembles the final product from components made in several locations. This takes place in vertically integrated industries such as electronics, medical devices and cars. Producer driven GPN’s accounted for 51.1 per cent of world manufacturing trade in 2012-3 and its share is growing; this is the trend Sri Lanka needs to tap into, according to Prof. Athukorala.

Successful integration of the manufacturing sector into producer driven GPN’s has played a key role in employment generation and poverty reduction in China and other high-performing East Asian countries.

The determinants of a country’s success in joining global production networks are the availability of trainable labour, proactive investment promotion and service link costs, according to the economist. He emphasised that while the importance of infrastructure and political stability to reduce link costs are often spoken about, Sri Lanka needs to focus on property rights protection, ease of enforcing contracts and a liberal trade and investment policy to attract FDI.

 

BOI no longer a one-stop-shop?

BOI was at one time a one-stop-shop for approvals. Now various ministries have passed legislation diluting the powers of BOI leaving investors with little choice but to approach ministries and line agencies. Sri Lanka Tourism has taken over the approval of industry specific projects and large scale strategic development projects are handled by the Treasury and the Cabinet review committee. Moreover there is a high degree of variability in incentives offered across various products/sectors and among firms with ample room for the discretion of BOI officials over actual viability and national economic gains. This creates unnecessary hassle and uncertainty for investors.

As the country is integrating into a global production network, it is necessary to import as well as export liberalisation; the free import of intermediate products and components; must go hand in hand with investment liberalisation.

 

AfD Vs BoI

Although Sri Lanka’s ministry tasked with attracting FDIs into the country and making the Indian Ocean island a prime destination for FDIs – the Ministry of Development Strategies and International Trade promised to present the Agency for Development (AfD) Bill to parliament last year – unfortunately Sri Lanka still lacks a fully-fledged legislative framework conducive to attract FDIs, The Sunday Leader has again and again reiterated. (See http://www.thesundayleader.lk/2016/07/31/making-sri-lanka-a-prime-destination-for-fdis/)

In 2015, Minister of Development Strategies and International Trade, Malik Samarawickrama told the media that he hoped to streamline and fast track FDIs into the country, and that it is highly unfortunate that with the other short-term and mid-term priorities of the government, the urgency of attracting more FDIs has had to take a backseat.

 

Regulating FDIs – COYLE

The necessity for scrutinising and authorising foreign investments: a) We observe that there is a gap in assessing real economic benefits to the country in terms of backward linkage, employment generation, technology transfer, environmental factors, etc., when FDI projects are approved by various institutions in the country. As at present, investments which do not make any positive contribution to the country are getting in through various channels. Instead of making a positive impact, these investments continuously drain away foreign exchange reserves of the country thereby hindering real economic development. There is no need to allow foreign investments that will eventually deteriorate the economy. Hence, we believe that there is a dire necessity for establishing a single institutional mechanism for all FDIs, to scrutinise and evaluate the suitability to the country rather than merely looking at the face value of the investments. b) We also request the government to revisit various investment provisions previously granted from time to time by the Sri Lankan Government through gazette notifications in the past facilitating undesired foreign investments.

COYLE also called for establishing proper domestic regulatory mechanisms with regard to provision of manpower and all services liberalised under GATS,  activating anti-dumping measures in Sri Lanka, the need of an effective national trade policy in formulating the way forward towards liberalisation and creating a level playing field for both local and foreign investors.

 

Australian model

Liberalisation of tariffs was reason that led Australia to become a formidable economic powerhouse and Sri Lanka is ideally positioned to become an economic success story of the region, Australian High Commissioner in Sri Lanka Bryce Hutchesson earlier told The Sunday Leader.

“One of the main factors that led to our growth was significant reduction of tariffs. Of course, some industries were hit but it created competition that led to the birth and growth of new industries,” said a confident  Hutchesson to The Sunday Leader.

“We can’t prescribe approaches, but we have found free trade agreements (FTAs) with major trading partners to be positive instruments in spurring growth. Sri Lanka’s strategic location, infrastructure, quality of educated workforce makes it an attractive destination for import, value addition and re-export,” he added.

“I have heard lot of Sri Lankan ministers say Sri Lanka is not the only girl on the beach. What they mean is that investors and traders will not come here because Sri Lanka is a nice country and Sri Lankans are nice people, even both those factors are true. It’s up to the government to work with in tandem with private sector to make this country an attractive investment destination. To achieve that, you need to get the right regulatory environment, ensure predictability, transparency and stability and safeguard an open economy,” he said.

Economists state that liberalisation and deregulation of the Australian economy was unique since it was spearheaded by a left-leaning labour government in contrast to right-leaning conservative governments. Liberalisation began in the early 1980s under the Labour Government led by Prime Minister Bob Hawke, which commenced the process of economic reform by concluding a wages accord with the trade union movement. In exchange for wage restraint and an increase in the ‘social wage’, the trade union movement agreed to support economic reform and oppose industrial actions. The success of the ‘Accord’ allowed a labour government to implement economic reforms that in other nations had been implemented by conservative political parties; tariffs were progressively cut, the Australian dollar was floated (1983), and the financial system deregulated. Hawke was also able to privatise several large government enterprises.

 

Reversal of liberalisation

Economists have lamented that although Sri Lanka had progressing towards liberalisation after the United National Party (UNP) government came into power in 1977, the  Rajapaksa regime had reversed the trend drastically between 2005 and 2015.

“While Sri Lanka’s industrial policy has been broadly market-oriented since liberalisation in the 1970s, the degree of outward orientation has wavered in the past decade. Two earlier rounds of economic liberalisation introduced a series of reforms towards deregulating the economy, accompanied by a strong focus on export orientation and FDI promotion. The last decade has seen a noticeable shift towards protectionism,” the World Bank stated in its last Systematic Country Diagnostic titled ‘Sri Lanka – Ending Poverty and Promoting Shared Prosperity.’

“The introduction of para-tariffs has effectively doubled the protection rates, making the present import regime one of the most complex and protectionist in the world. Moreover, the para-tariffs’ dispersion leads to prices that distort production and consumption patterns. Higher rates of protection on final products than on inputs used in their production lead to an anti-export bias, since producers have strong incentive to sell goods domestically even though their domestic costs are higher than their opportunity costs through trade.

This is particularly worrying for the agricultural sector, where high protection of import-competing crops along with fertilizer subsidies has created strong disincentives for crop and export diversification. Incentives are structured to expand production of import-competing crops (rice, maize) and discourage the production of exportables through the introduction of high export taxes (cesses) on raw materials such as tea, rubber, cinnamon, coconut and spices, with the notion that this would increase value addition of exports.

Revenues from cesses were supposed to be then invested in research and development for the corresponding sectors to encourage value addition, yet this has not been implemented.

“There has been an increase in para-tariffs in the past decade. This has not only significantly increased nominal protection and prices of imports, but has also added to trade policy complexity. The combined system of the Most Favoured Nation applied tariff rate and the para-tariffs has made the present import regime one of the most complex and protectionist in the world. Implementing para-tariffs has effectively doubled the protection rates to 24 percent.

“Worse still is the para-tariffs’ dispersion, which leads to prices that distort production and consumption patterns. Last, higher rates of protection on final products than on inputs used in their production lead to high effective protection rates and anti-export bias, because producers have strong incentive to sell goods domestically even though their domestic costs are higher than their opportunity costs through trade. This is particularly worrying in the case of the agricultural sector, given that a large share of the bottom 40 percent of the population continues to be agricultural producers. Trade barriers also make it more difficult for local producers to access inputs, reducing their competitiveness and ability to integrate in global value chains. Firms are also less likely to invest in capital equipment that would raise productivity and promote technology transfers.

“Stagnating product diversification and weak export performance has come on the back of an industrial policy orientation in the past decade that does not promote competition and aims to protect domestic industry. Although successive governments after 1977 carried out ad hoc import substitution policies, these did not have a significant aggregate impact on trade policy. The decade since 2005 has seen the most extensive measures were adopted, where the focus noticeably tilted towards promotion of domestic agriculture (with generous subsidies and guaranteed prices), domestic industries (with specific tax breaks and tariff protection), and wide-scale public infrastructure programs (particularly connective infrastructure like highways and ports).”

Forex regime liberalisation commendable

Many economists lauded the Central Bank of Sri Lanka (CBSL) for easing restrictions on remitting and transacting foreign currencies last February.

“Foreign currencies can henceforth be remitted out of NRFC, RFC and RNNFC accounts and FEEA for any purpose and prior approval need NOT be obtained for such remittances,” the statement said. Up to US$ 10,000 or its equivalent can be withdrawn in cash from such accounts for any purpose. Earlier money withdrawals were only allowed for certain permissible purposes such as foreign education or medical expenses.

Finance Minister Ravi Karunanayake presenting Budget 2016 announced that government would liberalise the current foreign exchange regime to promote Sri Lanka as a Financial Hub. Sri Lanka had huge potential to become an offshore banking centre standing to gain immensely from the consequent inflow of funds.

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