Dissecting the proposed National Policy for Industrial Development of Sri Lanka: Part 3

The apparel industry which was looked down in its early stages by sceptics is now the highest export earner for the country. What started as tailoring shops transformed themselves into environment friendly, elite, energy efficient factories any country could be proud of 

4. ROLE OF GOVERNMENT

The sections quoted in Part 2 of this article from the ‘Industry Diagnosis Report’ makes it clear that the Task Force has, as a lesson learnt from the past experience of Sri Lanka, concluded that the export-oriented trade liberalisation policies in the post 1977 period had a significant beneficial effect, inter alia, on the growth of the industrial sector, while under the import substitution policies “Sri Lanka encountered a range of economic setbacks, inflation, unemployment and Poverty were rising”. 

The report also states that an assessment carried out by World Bank in 2004 on Sri Lanka’s economic performance during the reform era stated that: “It would be hard to find a more convincing case of trade and industrial transformation of a small island economy through market-friendly policy reforms. By the late 1900s, the Sri Lankan economy was considered as one of the most open economies in the developing world.” It concludes stating that “several empirical studies have shown that outward-looking export promotion strategy has produced better results in accelerating the manufactured growth in contrast to import substitution strategy”. (Page 96)

The NaPID, based on the findings of the Diagnostic study, has in Section 4 of the Policy document set out nine ‘Policy Principles’ which captures the essential purpose of the Industrial Policy. The second of these nine principles is the following, “Competitive integration with international markets,” which objective was submitted by the writer as the preferred direction of the NaPID. It will be noted that the implementation of this principle viz. “Competitive integration with international markets” can be effectively implemented only against a framework of an export-oriented, open economic developmental policy regime being already in place within the country. 

In terms of this model, the state is expected to play a non-interventionist role, focusing mainly on the task of creating and maintaining a conducive environment for industry to function. The state, under the export-oriented economic model, was not expected to pick winners by which is meant, the selection of industries for investment, by the state (i.e. by bureaucrats). 

In this context it is interesting to read what the Task Force has to say about potential interventions by the Government in general, and the picking of winners, in particular.

Quote:

Overall learnings: Government intervention

There are two types of interventions; functional interventions and selective interventions. While functional interventions are designed to remedy generic market failures without favouring one sector over another, selective interventions are designed to remedy market failures for specific sectors/industries. Functional interventions are often preferred to selective interventions because of the risks (of “picking winners”) associated with the latter. It should, however, be noted that economic theory provides valid arguments for selectivity under certain types of market failures. Therefore, the challenge for the government is to balance between the two extreme approaches of “hands-off inaction” and “weighty interference”, but instead, one based on well-reasoned selective intervention. 

According to the World Bank, in order for national industrial policy to be successful, it is necessary to have three sets of factors viz. incentives, capabilities, and institutions. Governments may wish to intervene by slowing down the contraction of declining industries or speeding up the growth of new emerging industries, especially if there are strong compelling national reasons to do so. Even then, the rationale for selective interventionist industrial policy should be as transparent as possible. The best form of governmental facilitation is to dismantle and minimise barriers and obstacles in industrial development. 

Market mechanism combined with government-led planning

The appropriate economic regime for developing countries is neither a complete reliance on the market mechanism nor a return to the state-led economic planning. Therefore, government and market to be properly combined for each development task in a country like Sri Lanka where international competitiveness is lacking and markets are underdeveloped.

End quote. (Page 192 of the Industry Diagnostic Report)

The Task Force takes the view that “there may, however, be certain “thrust” industries and import substitution activities selected by the government for special assistance and protection. “Governments in many industrialising and industrialised countries in Asia and elsewhere have adopted such measures without harming an overall enabling policy environment. The primary goal of a policy regime that envisages effective and sustainable industrialisation should focus on the establishment of a pro-competitive business and policy environment, within which there might be thrust sectors selected for different economic, political and social reasons.” (Page 2 of the NaPID.)

It is seen from the above that the Task Force has no objection to functional interventions by the state. However, specific interventions, the report states, should be resorted to only under certain types of market failures, and when resorted to, should be transparent as possible. The report also points to the need to steer a course in between what it calls “hands off in-action” and “Weighty interference”. Is the picking of winners “weighty interference”? 

The Task Force is of the view that the appropriate economic regime for developing countries, is neither a complete reliance on the market mechanism nor a return to the state-led economic planning. The challenge is to strike a balance in the middle specially, in functioning democracies where the Politicians have to go back to the people periodically and win their support in order to remain in Power. Consequently, politicians are under tremendous pressure to please their voters. What is the likelihood that a decision by this Government or any other Government, for that matter, to specifically intervene, will be a rare instance of Politicians acting in a bipartisan manner? 

Our own experience, under governments of different hues has demonstrated that the likelihood of “politics” influencing the decision to specifically intervene is more than a risk. It is an event that is very likely happen. Its occurrence in fact, is envisaged and provided for specifically, in the draft policy document. A careful reading of the last sentence of the above paragraph, will confirm that. One cannot think of a defensible and objective rationale for proposing “Political reasons” as a criterion for selecting thrust industries.

That aside, although advocates of a liberalised policy regime may object to the state being permitted to specifically intervene even in exceptional circumstances, there may be occasions that warrant such intervention. Let me cite two such examples. 

Sri Lanka annually imports approx. 600 metric tons (2019 /556 MT and 2020/ 683 MT) of sugar into the country annually spending in excess of Rs. 51 billion in doing so. There are locations in Sri Lanka where climatic conditions are ideal for the growing of cane. There has been a State sector investment into the manufacture of sugar in the past. That enterprise has not been a great success perhaps due to legacy problems referable to Government ownership. 

The manufacture of sugar may be a profitable venture if the private sector owns and operates it. If so, advocates of the import substituting economic model may raise the question as to why the private sector has not shown interest in investing in this industry. The answer may lie in the nature of the project. A project to manufacture sugar is very likely to be one with a significant capital cost. The locally-manufactured product will have to be sold at the price at which the imported product is sold. It is said that growers of beet, feeding the sugar producers in Europe, are heavily subsidised by their governments, resulting in the sugar that is exported being sold at prices that local manufacturers may not be able to match. In other words, the product is being technically dumped into our market. 

However, if all of the above factors are fully investigated and a financial appraisal based on the conservative assumptions (such as maximum yields from the cane farms and optimum efficiency in the production can only be achieved in the third year of operations) it shows that the project will break even only in the third year of production and private sector investors may not be enthusiastic to commit substantial capital to set up the project. In such a situation if the Government decides to make a specific intervention to support the project during the first three years, would that be objectionable for the reason it is an import substituting project or that there is specific intervention by the Government?

There are also significant economic benefits such as being a source of income to small holder farmers growing sugar cane and saving of foreign currency that support the promotion of the project.

Consider the case of milk powder being imported into the country. Sri Lanka annually imports approx. 95 million tons of milk powder spending in excess of Rs 58 billion in doing so. There is no reason why we cannot expand our dairy industry especially in the upcountry estate areas and be self- sufficient in milk. Milk production in the country is on an upward trend during the last few years. However, based on the average annual growth during the last few year, it will take us many more years to reach self-sufficiency. Would direct intervention by the Government via the introduction of incentive schemes to accelerate the growth of the dairy industry be objectionable on the ground that it is an import substitution project or for the reason there is specific intervention by the Government? 

These two instances demonstrate that one should not be dogmatic in holding on to a particular ideology but be flexible enough to support ideas and projects that are structured on a different economic model, provided they are in the best interests of the country.

The Industry Diagnostic Study refers to the outcome of an exercise to select priority sectors that displayed potential for growth, as published in the ‘Vistas for Prosperity and Splendour’ document. The priority sectors identified were broadly categorised under eight headings such as; Industries related to food security, industries that can harness least used resources, etc. A more systematic study carried out in the course of preparing the NaPID, by a Study Team using a panel of consultants, is also detailed in the Industry Diagnostic Report. 

In this instance the consultant panel had used 34 comprehensive selection criteria organised under four different categories, viz. Growth potential, Competitiveness, Intervention potential and Sustainability. These criteria took into account the need to move away from high labour intensive sectors to technology-driven sectors, and from traditional primary products to non-traditional industrial products which were also likely to generate a demand from markets overseas.

The selection process included discussions and seminars with focus groups so that the whole exercise was in the nature of a public/private collaboration project. However, the selection of a large number (25) as thrust industries conveys the impression that the selection process was not as restrictive as envisaged. It is also likely to result in the selection process becoming political with many more industries canvassing to acquire the thrust industry status. A regular procedure for selecting thrust industries by the awarding of marks and weightages to theoretical criteria, and conducted by bureaucrats is just what should be avoided.

The Korean experience of the success achieved by some ‘winners’ selected by the state is often sited in support of the practice of selecting winners by the state. However, Professor Athukorale in his paper referred to earlier shares the following views on the subject. Quote:

When talking about sector/industry specific approach to industrialisation, we should not forget the fact that the Post-World War II economic history of developing countries, including that of Sri Lanka, is littered with cases of costly failure. Or course there were a few seemingly successful cases in some countries, but the available evidence clearly supports the view that these ‘successes’ were rooted in three fundamental traits of the industrialisation policy regimes of these countries. First, the incentives given to the specific industries were strictly time bound; second, export performance requirement was strictly imposed on the beneficiary firms; and thirdly selective intervention was undertaken in the context of an overall economic setting that was conducive for private sector operations. It is pertinent to quote here the founding father of the Korean economic miracle: 

“The economic planning or long-range development program must not be allowed to stifle creativity or spontaneity of private enterprises. We should utilise to the maximum extent the merit usually introduced by the price mechanism of free competition, thus avoiding the possible damages accompanying a monopoly system. There can be and will be no economic planning for the sake of planning itself – Park (1970, p. 214).” 

End quote. (Page 29. Rethinking Sri Lanka’s Industrialisation strategy – Prema-chandra Athukorale)

Specific interventions have been justified in instances where a potentially high performing industry has been identified by an entrepreneur who has proceeded to setup the project on his own initiative. Having realised the enormous opportunity to expand capacity and not having the resources to do so himself, approaches the Government for assistance. The Government seeing the high potential for growth decides to intervene and provides assistance to expand the industry. In this instance the Entrepreneurial Risk had already been taken by the investor without any assurance of support by the state. Assistance by the Government in this instance, it is submitted, will not be a case of the state picking winners. 

The garment industry in Sri Lanka is a good example of this model. The garment industry started on its growth path when two 30-year-old businessmen from Sri Lanka were able to convince a 50-odd-year-old businessman Martin Trust from the United States of America to end his search for a suitable location to set up a garment manufacturing facility, by choosing Sri Lanka as his preferred location. 

Having realised the huge opportunity to expand capacity, some industrialists approached the incumbent President at that time for assistance. The President realising the huge potential for growth of the sector and in particular the potential for creating employment specially in the rural areas of the country, initiated the 200 Garment Factory Project, extending an attractive incentive package for private sector investors. 

The industry which was looked down in its early stages by sceptics is now the highest export earner for the country. What started as tailoring shops transformed themselves into environmentally-friendly, elite, energy efficient factories any country could be proud of. Thomas. L Friedman, the Pulitzer Prize winning foreign affairs correspondent of New York Times, in his celebrated book ‘The Lexus and the Olive Tree’ expressed his impressions of the cleanliness of an apparel factory he visited in Sri Lanka, by stating “you could have your meals off the floor of this factory”. The apparel sector is therefore a good example of how Government can help exploit the potential in a sector which has already been identified by an entrepreneur. 

A lesson to bear in mind in case an industry already started by an industrialist showing significant scope for rapid growth comes up with a request for recognition as a thrust industry, or for specific assistance from the Government, is to ensure that in the restructuring of the project, the Government should never assume the role of the principal sponsor of the project. The financial risk in the project should not be largely on the Government. This not in any way a reflection of the incapacity of the Governmental nominees on the board of that company. It is because a Government that is elected by popular vote, cannot play an entrepreneurial role and take commercial decisions that may not be popular.

Before concluding this section on the ‘Role of the State,’ I must draw attention to a thought-provoking article contributed by respected Economist Dr. Godfrey Gunatilleke, under the title ‘The Krugman-Linked Economic Policy Discourse’ (Daily FT, Friday 8 October 2021). 

Dr. Gunatilleke points out that although the two political regimes that alternatively shared political power during the 72-year post independence period, were each identified rigidly with either the capitalist or the socialist model, in fact, the era produced an overarching policy mix in which the two politico-economic models co-existed with shifts in emphasis as one party succeeded the other. The Sri Lankan development strategy incorporated elements of both Capitalistic and socialist models along with changes of government.

Dr. Gunatilleke deals extensively with the views expressed by economists of international repute on the role of the state in economic development. He refers to Krugman’s “basic premise of an economic model, in which the state plays a proactive role in providing the macro policy framework of development goals and values within which the market functions. This is the normative approach and presumes a vision of the good society and a value system from which the goals are derived”. This sounds similar to the direction setting role assigned by the Task Force to the Sustainable Development Goals, dealt under section 3 of this paper. 

Dr. Gunatilleke refers to the “interminable and inconclusive controversy” that rages between proponents of the free market, minimalist state model and advocates of the normative approach in which the state is assigned a proactive role in providing the macro policy framework of developmental Goals and values within which the market functions. 

Although one can appreciate a role for the state, in providing a macro economic framework of development goals and more particularly “values,” when devising a model for directing and managing the Economy as a whole, how relevant would “values” be when directing the path for development of the industrial sector? The values would constitute rules for passive compliance rather than an active force that drives the industrial sector to reach a defined goal. 

(To be continued)

(The writer is former Secretary to the Ministry of Industrial Policy, Investment Promotion, and Entrepreneurship development, and former Director/CEO of The National Development Bank of Sri Lanka.)