Competing for FDI: An agenda for Sri Lanka

The world’s economies are competing for investment, in order that they create jobs for their citizens and trade effectively in goods and services in this globalised world economy. Barriers and restrictions are tumbling down as nation states compete against each other, to become attractive to investors.Competitiveness is a comparative concept of the ability of a country to sell and supply goods and/or services in a given market. Competitiveness captures the awareness of both the limitations and challenges posed by global competition, at a time when effective government action is constrained and businessmen are faced with significant barriers to competing in domestic and international markets.

To a great extent, the opinion on a nation state’s ability to compete to attract FDI is one of perception regarding the business climate. This perception is often based on anecdotal criteria. Business share experiences they have regarding dealing with the state and draw their own conclusions on the investor friendliness or hostility of the business environment in that particular state.

Quantifying competitiveness

However, there have been attempts made in the recent past to quantify the level of competitiveness and the business climate against some objective criteria within a fairly wide range of indicators.

The Global Competitiveness Report of the World Economic Forum defines competitiveness as ‘the set of institutions, policies and factors that determine the level of productivity of a country’. The World Bank has its Ease of Doing Business Report. The World Economic Forum – the Global Competitiveness Report. Transparency International – the Perception of Corruption Index.

The Heritage Foundation and the Wall Street Journal jointly produce the Index of Economic Freedom. The European Business School INSEAD produces the Global Innovation Index. The UNDP – Human Development Index. The World Bank together with some other partners produces the Logistics Performance Index. The Economist Intelligence Unit reports on the Business Environment. The World Bank also had an Enterprise Survey in 2004. The other Reports are updated for 2010 or 2011.

National Competitiveness Programmes

Nation states have National Competitiveness Programmes (NCPs). The NCPs are normally led by the highest level in the political structure, there would be a co-chairman drawn from business. The role of the state in policy and strategy formulation, oversight and implementation is given prominence in some cultures. Alternatively it is accepted that the business community would have a clearer diagnostic analysis of the problems facing the economy and a compelling vision that it is inclusive and appeals to a broad set of actors who are willing to seek change and implement an outward oriented growth strategy.

NCPs should recognise the importance of networks of firms operating in clusters as an organising principal of collective action. Practical experience has shown that a bottom-up approach that supports the networking of private entrepreneurs , civil society and public institutions  and not subservient to the political leadership has the best opportunity of identifying properly the real barriers to competitiveness, develop joint action programmes to revise strategy and policies to attract investments and yield better results in implementation.

National competitiveness strategies are believed to be particularly relevant to medium sized open economies, which rely on trade and FDI to provide the scale necessary for productivity increases to drive increases in living standards.

In Ireland for example the National Competitiveness Council uses a Competitiveness Pyramid to simplify the display of factor which affects Ireland’s competitiveness. It draws a distinction between policy inputs in relation to the business environment, the physical infrastructure and the knowledge infrastructure and the essential conditions of competitiveness that good policy inputs create.

Innovation and creative capacity

Innovation and creative capacity is seen as an important of aspect of competitiveness. In the USA the International Economic Development Council (IEDC) in Washington published an ‘Innovation Agenda: A Policy Statement on American Competitiveness’. It summarises policy recommendations for economic developers, federal and state policy makers that aims to ensure the America remains globally competitive.

The Reagan administration had Project Socrates to determine why US competitiveness was declining and create solutions for restoring US competitiveness. The project delivered the Socrates Competitive Strategy System and concluded that the source of all competitive advantage is the ability to access and utilise technology to satisfy one or more customer needs better than competitors, where technology is defined as any use of science to achieve a function.

Some nations allow individual regions/provinces and states within the nation, which have their own local government to compete with each other to attract foreign investment. This is one factor cited by Chief Executive Officer of Coca Cola Corporation Muhtar Kent, speaking on the sidelines of the Clinton Global Initiative conference in New York, to express the view that the United States of America is becoming less friendly to business and investment than China.

“In China local governments are fighting for foreign investment with each other,” Kent said. Further Kent expressed the view that there is a one-stop-shop operating or foreign investment in China, in terms of the Chinese Foreign Investment Agency. Kent compared this with the political gridlock and polarisation currently existing in Washington and America’s antiquated tax structure, factors which make Coca Cola’s home market less attractive when compared to China.

Kent compared China to a well managed company. He even went as far to say that Brazil was fast becoming more attractive than the USA for foreign investment. Kent’s view was that emerging markets were learning very fast as to the factors which investors are looking for.

He said: “In the West, were forgetting what really worked 20 years ago. In China and other markets around the world you see the kind of attention to detail about how business works and how business creates employment.”

He compared the way in which China’s provincial governments clamour to lure investors and lamented that American states do not act in that dynamic manner. He added that China’s economic growth and budget discipline, in comparison to the Europe, Japan and the USA, made it an appealing place to investors. Kent said that China “had seemed to have effectively cracked the code for growth,” which foreign investors found appealing, combined with the fact of the huge market and the burgeoning middle class with humongous purchasing power.

Compare the foreign investors’ more cautious attitude to India, also with an ever-expanding middle class, a growing economy, but burdened with a negative reputation for corruption and bad governance both at the union and state levels. Narendra Modi’s Gujarat is an exception, but it is also tainted by communal clashes and the BJP’s Hindutva credentials.

Sri Lanka and FDI

Sri Lanka too is on a campaign to attract Foreign Direct Investment. It is reported that that the target Sri Lanka has set for itself for FDI in 2011 is 1.5 billion dollars. In the recent past Sri Lanka has made strenuous efforts to improve our ranking in the World Economic Forum’s (WEF) Global Competitive Index (GCI).

The WEF defines competitiveness as an assessment of the set of institutions, policies and factors which determine the level of productivity of an economy. The capacity of that economy to achieve a level of prosperity for its stakeholder citizens is considered to be indicated by its productivity.

This prosperity is inexorably linked to the return an investor can obtain for a financial investment made in that economy. Where an economy achieves a good mark in the GCI, it is taken as an indicator that investors will be willing to investment their funds in that growing economy to obtain a good return for their investment.

In 2009 Sri Lanka’s position in the GCI stood at 79. With the defeat of terrorism Sri Lanka’s standing went to 62. In 2011 Sri Lanka is at the 52nd place out of 142 economies. A concerted effort by a number of task forces and working groups to address the factors for which Sri Lanka scored low marks has resulted in this improvement.

Combined with the defeat of terrorism and the opening up of the markets and productivity of the north east, stronger interventions by the entrepreneur and improvements in infrastructure are the factors which have brought about these improvements.

Inhibiting factor

Among the many factors which would inhibit an investor from placing his trust in the Sri Lanka economy, one would be the effect of some recent judgments, which can be taken to mean that, where State assets are involved, there is no time bar for a challenge to a transaction due to an alleged violation of fundamental rights or noncompliance with due process. This would be in effect mean that where an asset belonging to the state has been sold to an investor or state land has been leased to an investor for example, where there is alleged a violation of fundamental rights of a litigant or where the letter and maybe even the spirit of the law, for due process purposes, has not been complied with, or cannot be prove to have been complied with, even by sworn affidavit evidence, where there is no opportunity to test evidence by cross examination under oath, even a decade later, the whole transaction can in theory be challenged and overturned.

The State is the largest owner of land. There have also been news stories of the State showing interest in disinvesting some industrial establishments, investor interest in these sectors will be inhibited by these factors. Changing this situation may require legislation to provide for certainty and final closure of a transaction, within a given time frame.

Workforce constraints

The quality of the work force is another area. Although Sri Lanka has had free education for a number of decades, the quality of the end product is not up to what the market requires.

In 1971 Professor Dudley Seers of the Institute of Development Studies of Sussex University, pointed out the ‘mismatch’ which existed between the end product of the process of education and skills demanded by the labour market. Four decades later this word ‘mismatch’ is still an integral part of the Sri Lankan educationists and manpower specialist’s lexicon!

Constraints on labour mobility are also a factor. The cost of termination of service inhibits recruitment. Generous welfare benefits for employees and costly termination benefits impose a cost burden on entrepreneurs, which they will not always face in other economies.

The success of family planning programmes in Sri Lanka has resulted in a dramatic slowdown in the birth rate, this factor combined with a large outflow of unskilled workers to West Asia and other labour importing economies and high recruitment into the defence services has resulted in all labour intensive industries in Sri Lanka running short of labour.

The garment industry making a virtue of their ability to retain workers is a reflection of this problem. So also the anecdotes on ‘visa on arrival tourists’ found working illegally. The highly-centralised nature of the promotion and approval of foreign investment has led to a concentration of investment in the south west of the island.

Other than the plantation industry, for which natural conditions required development in suitable climatic conditions in the interior of the country, the only exceptions to this were the investments made in the very early post independence period at Kakasanthurai (cement), Valachchennai (paper) and Paranthan (chemicals) and the 200 garment factory programme.

Provinces should be allowed the freedom to selling their investment potential in competition with each other to potential investors, subject to Government regulation, as in China as elucidated by Muhtar Kent of Coca Cola.

These are only a few of the serious policy constraints which should be addressed if Sri Lanka is to meet its target for FDI in 2011. It should be noted that investments by foreign governments and state entities, directed by strategic, political, sympathetic or whatever other reasons, cannot be counted when calculating investment by private entrepreneurs, for setting up productive establishment to add value to a resource available locally and selling it globally, adding value or providing a service to a global market and giving the work force new skills.

Investing in developed economies

Traditionally FDI is seen as something which originates in the developed economies which is invested in emerging economies. However, the World Bank recently reported that more and more emerging market firms are, by mainly using cross border mergers and acquisitions, investing more and more in developed economies.

For example India’s share of cross border mergers and acquisitions rose to 17% in the seven years up to 2010, in the previous seven years it was just 4%. Such investments are also a source of more than one third of all FDI in other emerging markets.

While such investments in other emerging markets by Indian firms is organic – setting up a local branch office or manufacturing unit, Indian investments in developed economies are ‘acquisitive,’ by purchasing another company.

The bulk of such emerging market acquisitions are by five countries led by China and India. The USA is the main recipient, closely followed by Britain. Commodity rich Australia and Canada have also attracted such FDI form emerging markets.

Mansoor Dailami, one of the authors of the World Bank report, says the reason for emerging economy corporates to invest in developed economies is access to new customers. “As a company you don’t want to be confined to local growth. You want to have the global economy as your market.”

Some examples of Indian conglomerates which have invested in Britain are: The Halewood, Jaguar Land Rover car plant near Liverpool owned by Tata Motors, the Stanlow oil refinery owned by Essar, Brunner Mond chemical factory owned by Tata Chemicals and the football team Blackburn Rovers owned by VH Group, an Indian poultry firm. In the case of the Halewood car factory, Ratan Tata confessed that “the chance to own the Jaguar brand was irresistible.” Competitiveness could take many varied dimensions!

Krugman’s position

However, it is interesting to note that Nobel Laureate Economist Paul Krugman is of the view that “as a practical matter, the doctrine of competitiveness is flatly wrong. The world’s leading nations are not, to any important degree, in economic competition with each other.”

Krugman’s position is that national economic welfare is determined primarily by productivity in both traded and non traded sectors of the economy.

Nation states, in order to create jobs for their citizens need to attract investments, investors respond to incentives. One major incentive undoubtedly is the certainty of the return on the investment. Where this is doubtful, the investment will not transpire. So economies must ensure that the investor is confident of the economies capacity to ensure a certain definitive return on the investment.

The varied factors described in the foregoing, will be critical in the investor making a judgment whether to invest in a developed or emerging economy. Nation states must address these issues to attract private investors.

Sri Lanka’s strategy

Recently at a workshop organised by the Pathfinder Foundation together with USAID and VEGA, on ‘Beyond the Ease of Doing Business Index: What Should be Done to Improve the Overall Business Climate in Sri Lanka?’ the strategy Sri Lanka seems to be adopting in trying to address the issues taken for computing the Ease of Doing Business Index, to achieve improvements in the business climate and competitiveness, was questioned. This approach was considered to be nitpicking, working on minor side issues, when what is required is a revolutionary transformation in the big picture. The nation’s attitude to foreign investments, as seen by perceptive watchers of the business climate, has to be radically transformed from one of suspicion and perceived threat, to one which welcomes investors as wealth and job creators.

If this attitudinal transformation could be achieved and communicated effectively, the perception on Sri Lanka’s business climate and competitiveness would be positive and be more permanent than minor changes in indicator points in the indexes which we seem to be targeting.

It is sad that at the time of writing the demise of Steve Jobs of Apple, undeniably the world’s most competitive innovator of our epoch, is reported. His Commencement Address at Stanford University on ‘Connecting the Dots’ is a classic of its genre and a must read. Sri Lanka has to revamp our process of education to produce such competitive innovators. More on that agenda item later.

(The writer is a lawyer, who has over 30 years experience as a CEO in both government and private sectors. He retired from the office of Secretary, Ministry of Finance and currently is the Managing Director of the Sri Lanka Business Development Centre.)