Will Free Trade (FTAs) Lead to a ‘Powerful’ Sri Lanka? THE IMF IN SRI LANKA – Part III
Posted on March 17th, 2017

Small & Medium Enterprises (SMEs) – Low Export Viability under FTAs.

In Sri Lanka, approximately 99.8% of domestic sales are the product of small business concerns, and 83% of these are from medium-sized enterprises, both together accounting for more than 50% of GDP, and also 45% of total employment. Research done by the Institute of Policy Studies (IPS) has also shown that SMEs are significant in the employment sphere as employers of women and youth, a disadvantaged minority in our country.

A large number of constraints to the operation and growth of SMEs, which are, therefore, so critically important to the Sri Lankan economy, have not been relieved hitherto by policy makers but difficulties affecting their business prospects will also be aggravated by liberalizing further the country’s trade regime. So also by the proposed adoption of IMF-advised and supported free trade pacts with several countries, which are at a more advanced stage of industrialization. These FTAs are now in almost confidential but active negotiation status, without full consultation with SME representatives, who are potentially the adversely affected stakeholders, vulnerable to increased foreign competition at this early stage of the country’s industrialization.

The research done by IPS has also discovered that “trade barriers, poor access to information, costly requirements in regulations, burdensome customs procedures and shortage of trade finance, as being major barriers to SME’s role in the export trade”. Lack of access to information about border procedures and regulations operative in foreign markets; easy access to trade finance; unfamiliarity with the marketing know-how needed to adapt SMEs’ local products and packaging techniques in order to meet external market requirements; their inability to provide collateral, bank guarantees and credit history, entailing higher interest rates for SMEs; and lack of dedicated trade facilitation-related financial services have variously been identified in the same IPS study. These constraints cumulatively contribute to substantially reduce SMEs’ export potential, and should be ameliorated to stimulate and encourage their ability to compete in foreign markets. Opening domestic production to more sophisticated import competition will operate as a serious drawback to SME business viability.

The gross neglect of these issues by the Government is surprising. Of the constraints identified above and presented by SMEs, not only in formulating trade policy but also in ongoing negotiations for FTAs, which, per se, entail neglect of the prime need to ‘protect’ these SME businesses, employing a large proportion of the population, dependent on employment countrywide by them. Already, the steep increase in living costs resulting from IMF-decreed increased VAT and the imposition of a Nation Building Tax (NBT) on SMEs, which pass on these regressive taxes to consumers, have not only reduced consumer demand, but also contributed substantially to inhibit their export drive, resulting in reduced profitability, and caused problems for the livelihood of a large segment of the people employed in SMEs, importantly women and youth (who already have other constraints in obtaining gainful employment, as commented earlier), and a sizable number of SMEs who are owned and run by women. (This writer is indebted to studies done by IPS, and its outstanding trade policy analysts, for data and related arguments presented in the foregoing section as summarized by Dr Janaka Wijayasiri in ‘The Island’ of 1 December 2016, and also elsewhere in this essay).

Now, the Government has issued mandatory instructions through the Central Bank to all commercial banks urging them to lend at least 10% of their total loan portfolio to SME businesses throughout the country. (Whether the instruction to also lend 10% for agriculture, 5% to women and 5% to youth is complementary to the special lending allocation to qualified SMEs is not clear), but critics have pointed out structural deficiencies in the system, including the lack of information to potential borrowers about which business sectors are profitable; the lack of technical knowledge and skills to undertake businesses in their respective areas; the inability of many borrowers to present their case for loans in a way acceptable to lending banks; the lack among borrowers, especially women and youth, of needed collateral and security demanded by such banks; and the perception among banks that the sector of business identified by potential borrowers may not be a profitable one or the borrower is not creditworthy. A mandatory Central Bank direction to lend a minimum proportion to SMEs, women or youth, without and before policy makers take adequate measures to address these preliminary but significant, structural issues may be doomed to failure.

A substantial proportion of SMEs in rural and suburban areas, are also mainly involved in agro exports, which are inhibited by their own special structural constraints, relating to: failure overseas of Sri Lanka’s food safety standards, governed by an antiquated Food Act, many decades behind modern international standards; a basic focus on primary agro exports with still little or no local value added; inability to make a quick response to changing western and other sophisticated consumer demands, especially since politicians are in the driving seat in our country, unlike in India and other more advanced Asian economies, instead of technocrats. Our country produces not enough food scientists – therefore, the emphasis is on ‘quality’ of exported products, evaluated by unqualified personnel, and not food ‘safety’, which is the significant deciding factor in international commerce. (“Why Sri Lanka is an Agro Export Failure”, CT, 10 March 2017).

Export Finance – Role & Significance.

The Government has allocated Rs 10 Billion to establish an EXIM bank in Sri Lanka, now recognized universally as a significant facilitator of export promotion, and helpful in meeting export targets. Export finance has an important role to play in the country’s efforts to revive its declining exports by: facilitating payment and export terms to exporters; help the exporter and buyer to share risks in international transactions; provide export insurance, loans to meet working capital requirements for export as well as for strategic export credit schemes, e.g. credit guarantees, interest rate support, etc; provide buyers’ credit even to the importer; reduce the risk premiums levied on loans to SME exporters, which now increases their borrowing cost; and help incentivize the private sector to explore, access and diversify into new foreign markets and add value to products. (Extracted from a Verite Research Study summary, December 2016).

International Investment – Poor Sri Lanka Experience?

A primary objective of Sri Lanka entering into FTAs with industrialized, more advanced countries is also to mobilize foreign, bilateral investment through an investment component, with attendant technology transfer. In addition, Sri Lanka has entered into separate Bilateral Investment Treaties (BITs) with the same foreign investment objective – 21 in the 1980s-90s, and 5 during the 2000s; of the latter, only one has been ratified and is in force. Evidence does not support the “conclusion of causality between the presence of BITs and increase in FDI flows…and also reveals inconclusive evidence that FDI flows increased after entry into force of a BIT… Sri Lanka avoided finalizing or ratifying any new BIT since 2009…Sri Lanka seems to be very careful in entering into new BITs in the future” (Malalgoda & Samaraweera, “The Experience of Sri Lanka with International Investment Treaties”, South Centre-Investment Policy Brief, December 2016).

Free Trade Policy : Specific Country Issues.

The wisdom of negotiating preferential, supra-national free trade agreements (FTAs) is questionable, without first establishing a viable export industry strong enough to withstand international trade competition, as was done earlier by the ‘miracle’ economies of East Asia, in relation to more industrialized countries. Advisability of proposed FTAs with China, Singapore and India, inter alia, with all of whom Sri Lanka has substantial adverse trade balances, historically as well as currently, has come into serious doubt by both stakeholders like the SMEs as well as by concerned professional associations, like the economists and exporters and Chambers of Commerce (as was pointed out in an earlier part of this essay). The Government, nevertheless, is pushing ahead speedily with finalizing such ill-conceived, anti-national and perverse trade policies which will further decimate business profitability and already declining export prospects, and kill nascent ‘basic’ industrial efforts, which are fully deserving of the import substitution safeguards proposed by local trade experts and professional economists’ associations – early policies which were sponsored during their speedy industrialization by the ‘tiger’ economies of East Asia (see this writer’s “The Development Strategy of the ‘Miracle Economies of East Asia”, The Island, 11February2017). A brief examination of Sri Lanka’s drawbacks in further liberalizing trade through FTAs at this early stage, and the advanced industrial status of the countries with which Sri Lanka is planning to speedily intensify trade liberalization, aimed at increasing export revenues, may be revealing at this point.

CHINA.

This is a country with the most automated industrial sector in Asia, barring Japan; China’s factories are rapidly replacing their workers with robots in an ongoing automation-driven industrial revolution, aimed at accelerating greater production and cutting rising labour costs, for further improving competitiveness. China has bought more industrial robots than any other country since 2013, in a determined quest for cheaper and more reliable industrial mechanics, performed with greater precision. China’s technological revolution has very far to progress, raising the six million dollar question: Can developing economies like Sri Lanka still hope to follow the conventional route to prosperity through enhanced trade liberalization, exporting low end products, e.g. leather goods and garments, to countries like China, now already the world’s biggest exporter of manufactured goods, or even Singapore, another sophisticated manufacturing base?

China’s central planners are offering generous subsidies, spurned by Sri Lanka’s economic guru, the IMF, to industrial concerns both to use and build robots, also upgrade them and capture new export markets – with a proactive Government throwing its full weight behind the domestic robot revolution. Meanwhile, as the demand increases the price of industrial robots is falling and their performance is improving progressively, enabling China to overcome labour shortages and rising costs (“China’s Robot Revolution” from Artificial Intelligence & Robotics).

Elaborating on the related ongoing FTA negotiation, the Sri Lanka/China trade trade between these countries crossed the high $ 4 Billion threshold, 93% (or $ 3.7 Billion) were imports from China into Sri Lanka, while Sri Lanka’s exports to China were valued at a miniscule $ 293 million (or 7%); and plans are to make this quite unbalanced bilateral trading relationship still more stark, and now sought to be further liberalized even more extensively and deeply under an FTA. Moreover, a significant proportion of Sri Lanka’s exports utilize major imported components from China itself, reducing the local value added significantly! During the last eleven years when Sri Lanka/China bilateral trade ballooned nearly six-fold from $ 659 million in 2005, the proportion of Sri Lanka’s exports to China did not increase due to numerous structural factors, adequately detailed and summarized in previous parts of this essay already, extracted from SLEAS and IPS commentaries – but principally relating to the paucity of exportable products generated by a vibrant industrial sector in Sri Lanka, building upon a still-nonexistent, national industrial strategy, detailing a vision of a modern economy’s path to a “powerful” (balagathu) Sri Lanka.

It is relevant to mention here that the Second China Product Export Exhibition, launched last year in Colombo in late-November, and attended by a 120-strong visiting Chinese delegation, was further designed to exploit still more intensively and further expand currently existing trading advantages to China, coming from greater liberalization of even more preferential Sri Lanka/China trade, which is current government policy.

Trade policy analysts have also identified several lessons for Sri Lanka from the Pakistan/China FTA, derived from experience under it during the ten years of its operation, as follows: firstly, tariff concessions extended to Pakistan appear superficially generous, but despite Pakistan’s close and long-standing political and foreign policy relationship, China has awarded better or equal trade concessions to competing ASEAN countries, while also placing Pakistan’s more unique exports in the ‘non-concessional’ category, cumulatively resulting in the FTA eventually benefiting China more than Pakistan. The question arises whether our negotiating authorities have first consulted domestic businesses to ensure that FTA’s concessions are beneficial to Sri Lanka’s trading interests?

Secondly, China appears to benefit more from a number of products covered, and their variety under the FTA than Pakistan. So, is Sri Lanka negotiating an FTA which covers products with high export potential and enjoying competitive advantages in world markets, thereby diversifying its export basket? Thirdly, given the unequal benefits shared under the FTA and Pakistan’s steep adverse trade balance with China, very similar to Sri Lanka, exports from China keep increasing, causing income and revenue loss to Pakistan, necessitating increase in Pakistan’s export lines and expansion of product variety, rather than trying to discourage exports from China – a losing game at all times. Similarly, IPS research (from which these very cogent arguments are extracted), shows close to 300 items of goods imported by China, not being now exported by Sri Lanka, presenting new export potential for innovative domestic entrepreneurs, but they would initially need a ‘protected’ milieu to develop, possibly concessionary Bank credit and government export subsidies, which will cause IMF’s loud megaphone to be turned on again at policymakers – but this was precisely the early strategy of the ‘miracle’ economies to speedy global export success and prosperity, with equity for all.

Lastly, there is a serious potential danger to Sri Lanka from finalizing FTA’s with more industrialized countries – for instance, the FTA with China has resulted in increased imports of finished products into Pakistan, flooding the local market with cheap substitutes to locally crafted goods and reduced their demand and, therefore, profitability; also causing under-utilized capacity among local enterprises. Does Sri Lanka have the time and funds to extend speedy, subsidized support to local industry, rendered vulnerable by cheap Chinese competition flooding the local market? China has famously entered even other highly industrialized countries as well, like the U.S. and wiped out both entrepreneurs, and with it, employment on a large-scale – leading to loss of jobs and impoverishment of workers, one contributory reason for the recent regime change in that country. Sri Lanka is attempting to do what the U.S. industrial powerhouse could not do successfully, may be at similar or even worse costs.

Dr Janaka Wijayasiri, a trade policy expert at IPS, from whose original and imaginative research, the foregoing “Four Lessons of the Pakistan-China FTA for Sri Lanka, (Talking Economics Blog) are derived, has recommended that “Sri lanka should urgently enact legislation against anti-dumping, countervailing and safeguard measures…to ease the transition towards freer trade and protect local industries against unfair trading practices and surges in imports”. So, time is of the essence, but nothing happens that fast in this slow-moving, tropical paradise! In fact, local manufacturers are reported to be irked that a feared 90% tariff liberalization, with only a 10% negative list, covering substantially all trade, will allow cheaper Chinese products to certainly flood the market and adversely affect local industry, and will result in huge job losses. While China wants to fast-track the FTA signing, before India, in a typical Sri Lankan ‘cart before the horse’ scenario, responsible bureaucrats have been, ex post facto directed to undertake a comprehensive sector-wise analysis to identify industries which will be affected, with data on their exports, employment, turnover and production volumes, at this very late stage, after the FTA horse has in fact almost bolted! Better late than never, hardly works at this critical juncture, because, very sadly poor peoples’ livelihoods are at stake here.

To be Continued

5 Responses to “Will Free Trade (FTAs) Lead to a ‘Powerful’ Sri Lanka? THE IMF IN SRI LANKA – Part III”

  1. Dilrook Says:

    The biggest danger is not a FTA with China but ETCA with India.

    The article contains many inaccuracies.

    Although China has enormously increased the use of robots, it has not automated production to a great extent. Singapore is another country that has very little robotic production compared to manual work. Due to the middle income trap (at the high end), many industries in China becomes unprofitable.

    China’s GDP per capita (nominal) is $8,216. It is only $3,870 for Sri Lanka. By relocating production to Sri Lanka, China can save (and Sri Lanka can gain) $7,214 per year per employee on average. This is a huge saving for China and a huge earning for Sri Lanka. For Sri Lankans, these are a step up in their salary, skills and technology. In addition, by basing production plants in Sri Lanka, China can cut down freight, insurance and cost of exports to Europe, the Middle East and Africa enormously. The total of saving per employee can be estimated at over $10,000 per person employed in Sri Lanka.

    However, it is the opposite with India. Its GDP per capita is only $1,719. By relocating manufacturing from Sri Lanka to India (or by flooding the Sri Lankan market with Indian cheap goods), India can earn $3,656 per worker and Sri Lanka will lose $3,656 per worker of Indian affected industries.

    The gap between the benefit from a FTA with China and the loss from a FTA with India is $10,871 per worker. This is the difference in a FTA with China and a FTA with India.

    Sri Lanka gains $7,214 per worker with a comprehensive FTA with China but Sri Lanka loses $3,556 per worker with the FTA/ETCA with India. The difference is $10,871 per worker in favour of China over India.

    It is not difficult to understand this in other fields (other than economics) as well. In politics, defence, respecting internal affairs, etc. China is light years ahead of India.

    However, I agree Sri Lanka cannot become a “powerful” country by competing on low cost of production and becoming workers. To be prosperous and powerful, Sri Lankans must become the owners of businesses and investors. Profit goes to the owner, not to workers.

  2. Ananda-USA Says:

    Dilrook,

    How did you get $7214 saving per worker for China from the GDP values for the two countries?

    Also, that would apply only to Sri Lankan workers the Chinese actually employ. What if they intend to employ mostly Chinese in the Port and Industrial zones and few if any Sri Lankan workers?

    The Yamapalanaya, desperate to escape from under the Chinese debt has NOT SPELLED OUT that these facilities should employ mostly Sri Lankan workers!

    This is another example of the STUPID DEALS that the Yamapalanaya is making, without SECURING and ENSURING that the PRIMARY BENEFIT of the deal ACCRUES to Sri Lanka!

    With deals like thus, Sri Lanka will soon be in the poor house with foreigners lording it over us as in the British Colonial days!

  3. Dilrook Says:

    @Ananda

    GDP per capita is GDP divided by the total population. Only about 70% of the people earn it. The share of GDP per working person is that number.

    If they employ Chinese workers they have to be paid Chinese scale salaries (much higher as above) plus relocation, lodging and plane tickets. Otherwise they will not make the trip away from family. It becomes extremely unprofitable.

    During the construction of Hambantota, Nelum Pokuna, Norochchola, etc. some blamed the government for Chinese workers working on construction. That actually helped run these on budget (time and cost). However, once completed, locals work in them.

    I have lost faith in Sri Lankan regimes after 2010, however, this seems to be something even the regime can stop given the circumstances. UNP is the last government to allow China into Sri Lanka in any shape or form. The fools kicked out China and learned the hard way its friends are not willing to invest in Sri Lanka.

  4. Dilrook Says:

    Correction. 60% of the population earns it. The others are children, adults, not participating in the domestic product and the unemployed.

  5. Ananda-USA Says:

    Dilrook,

    Agree with you that we must be OWNERS to get the Lion’s share (after all, that is the right of SL Lions, ain’t it? LOL!) of the benefit, and not MERE WORKERS!

    But, we have TRADED AWAY the Lions share (80%) of the ownership, and most of the income it would generate!

    IN ADDITION, we have not negotiated that the Port would employ mostly Sri Lankan workers EITHER! So, we have SOLD 80% share without any jobs for our workers!

    What kind of a CRAZY STUPID ASININE ‘DEAL’ is this?

    As an R&D engineer and Scientist who earned most of his wealth by investing his employment generayed savings in investments I own totally, I HOWL from ANGER and WEEP for my people, when I read about how the Yamapalanaya is bankrupting our country!

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