Beyond subsidies

Both Sri Lanka Podujana Peramuna (SLPP) presidential candidate Gotabaya Rajapaksa and Democratic National Front (DNF) presidential aspirant Sajith Premadasa have outlined plans to continue and even possibly extend the fertiliser subsidy with plans to increase protectionism in the agriculture sector. This potentially costly proposal needs to be analysed at a practical level as it will cost a hefty amount of taxes.   

The concept of import substitution is an old one in Sri Lanka and was extensively practised for decades since Independence, including during the ‘Mahinda Chinthana’ days of Opposition Leader Mahinda Rajapaksa. But it has had mixed results. 

Import substitution generally involves imposing higher tariffs on selected items. But the result is often not an improvement in quality or competitiveness. This is because the tariffs take away any incentive for those involved in that production to be efficient and, particularly in Sri Lanka, simply provides a large chunk of earnings to the middle man.  This means that not only does the consumer have to pay higher prices for goods, but the producer does not benefit from the higher tariff as it does not provide technological advances or other techniques to be more efficient and competitive. 

Sri Lanka’s rice sector is a good example of this. Even though Sri Lanka has been self-sufficient in rice for over a decade, farmers are still heavily dependent on the fertiliser subsidy and struggle to be competitive. Without a captive local market they would not be able to earn through exports. This is also the reason why tariffs imposed for import substitution are difficult because they disproportionately impact the poor.  For decades, the dairy industry has been one of the most protected sectors in Sri Lanka, but even after absorbing huge amounts of public funds, it remains one of the least efficient and most contentious segments of the economy. Caught in the crosshairs of politics, bad decision-making, mismanagement, and outdated economic thinking, the dairy industry is a microcosm of how interventionist economic practices can harm both consumer and producer. 

On the surface, successive governments have justified billions of rupees worth of subsidies to the sector, on the basis that Sri Lanka spends over Rs. 40 billion annually to import milk powder, and have argued that import substitution would save the country precious foreign exchange while meeting nutrition needs. But this has had limited success, as the local industry has failed to be competitive. This is also why milk products such as cheese are expensive in the local market, despite the existence of large-scale local producers.

As part of the Government’s import substitution program, particularly under former President Mahinda Rajapaksa’s administration, the State spent billions of rupees on importing thousands of dairy cows and handed them out to small farmers in select areas of the country. 

However, farmer associations and experts have since pointed out that these cows do not suit the Sri Lankan climate and farmers are forced to spend significant amounts of money on their upkeep. Large numbers have perished over the years, and those left produce smaller volumes of milk than initially projected. After many trials and failures, milk production has improved, but little investment was made in establishing efficient delivery systems to consumers. 

Value chains are important for an industry to become competitive and deliver high quality products to consumers at a reasonable cost. It is absolutely important to support the agriculture sector, which employs 27% of the country’s population, even though it only provides about 7% of GDP. 

But the inefficient gap needs a diverse, long-term and data-driven policy approach to be successful. A dressed up version of old policies will not be sufficient and it would be refreshing to see more substantive policies from presidential contenders.