ECONOMYNEXT – Sri Lanka has a ban and taxes on the import of tea, preventing domestic value addition for export, supposedly to protect a Ceylon Tea brand, while also taxing exports of raw produce of farmers including cinnamon, supposedly to boost domestic value addition.

Both these positions cannot be true, since they are contradictory.

Both these acts of coercion and repression are supposed to benefit farmers, or the ‘country’, either in the long-term or short term.

Many of Sri Lanka’s tea exporters who export branded or bulk tea want to import and export blended tea. But companies like Dilmah tea in particular have been opposing the people’s freedom to import tea for a long time. So far they have been very successful in lobbying politicians and bureaucrats.

The arguments are all tied up in a lot of nationalism, patriotism and a case against blended versus ‘pure Aryan’, sorry ‘Ceylon’, tea.

But Sri Lanka’s tea industry was started by British planters when this country was under colonial rule. Therefore it is not a product to be very nationalist about and oppress an entire population. Cinnamon plantations were started during Dutch rule. Before that cinnamon was gathered in the wild. Cinnamon was a key source of export revenues, until ironically, export taxes killed the crop.

Why Blend?

There is no crime in blending tea grown in two areas. For people who are not familiar with the industry, all tea is blended.

In a factory the black tea that is produced today will be different from yesterday because the temperature or humidity that influenced the fermentation process and bacterial growth inside the factory is variable.

So what used to be called one 20-chest lot, similar to a day’s production, was different from another such lot.

Similarly, the tea in different elevations, different districts and produced at different times of the year do not taste the same. The challenge for an exporter is to deliver substantial quantities of tea to a foreign buyer with a uniform taste.

This is where tea tasting and blending comes in. Sri Lanka has expertise in this area.

So-called ‘quality’ of tea and its demand is based on individual preferences, or advertising and there is no objective measurement of quality.

Who buys Sri Lanka tea?

Turkey, Russia, Iraq, UAE, Iraq, Iran and Azerbaijan are our key buyers this year.

After the British owners were expropriated in a state intervention in Sri Lanka, they were given land by African nations. Countries like Britain became large importers of African tea. In Africa less labour intensive CTC tea is made.

It is to the credit of Sri Lankan exporters that they developed these new markets in the Middle East and Central Asia.

Sri Lanka’s key trading families who have historic links to the Middle East either through Arabian or Persian culture and religion have played a large part in this transformation. But they keep a very low profile.

Not many people even know that Akbar Brothers is Sri Lanka’s largest tea exporter.

Capitalists or owners of free enterprises work every day and look for ways to please their customers at the best quality and at different prices which are affordable to them and gain market share and profits. They typically do not have political skills, since their skills in pleasing customers are quite enough to make large profits. As a result they are frequently the target of taxes and other oppressions by the state, interventionists and nationalists.

Mercantilists and nationalists also try to make the highest profits but not by giving a free choice to the customer.

Mercantilists collude with those who have coercive power like politicians and bureaucrats and try to control either the customers or the producers by applying the power of the state backed by its capacity to wield violence either through customs duties, fines or jails. In other words, profits are made by robbing a freedom by tying the hands of a consumer or supplier, not through free competition with another enterprise.

Today, low grown teas fetch higher prices than high growns. Even Nuwara Eliya teas, once highly prized, are barely managing to trail behind.

There were no bureaucrats, nor a five year grand plan, or tax breaks to make low grown teas more sought after and prized more than the high grown tea. It was purely an exercise in free enterprise done in friendship and freedom. (In the midst of all this bought leaf factory owners always manage to get subsidies every time the commodity cycle turns, like in some weird politico-financial ritual.)

Neither the state planners nor the bureaucrats could imagine outcomes like this or even understand its value. This is what innovation and markets are about. Small holder tea production, which is mainly in the low grown sector has also grown fast while the larger plantations stagnated.

Auction Prices

Sri Lanka tea consistently manages to get high prices at auctions. According to Sri Lanka Tea Board data there was a gap of 69 cents between Colombo and Mombasa. How does this happen?

The farmers would say it is becase the ‘quality’ is high. But traditional ideas of quality have now been turned upside down with low growns getting higher prices and the more delicately flavoured high grown tea becoming second class.

Table: Auction Centres

In the first half of this year the average auction price in Colombo was 3.13 US dollars a kilo. Neither Africa, nor India or Jakarta could match this. Mombasa was 2.54 dollars a kilo.

One of the reasons for high auction prices in Colombo is fast shipping connections. Another is the efficiency of our exporters, who are willing to give credit to buyers. Some buyers do not even pay until they sell the stock in the wholesale market and generate the cash to settle Sri Lankan exporters.

The auction process itself is efficients and samples are given to buyers and their representatives and are also jetted around the world to them before each lot hits the auctions.

Colombo has mainline shipping calls which makes it easy to ship tea to a buyer within the shortest time. Time is money.

The number of ship calls in Colombo vs Mombasa or Jakarta or Vietnam has an effect on the tea price.

Sri Lankan exporters also have skills in shipping goods to neighbouring countries when sanctions are in place in the Middle East. Not that these skills are much talked about. The farmers may not know much about this.

That farmers understand very little about international marketing can be seen when they did not protest as rubber and tea export taxes were raised several times during the Rajapaksa regime.

When export taxes are raised, Sri Lankan goods can be priced out of the market. If they are not priced out, the farmers will bear the cost with lower prices than they would otherwise have got for their produce.

Blending Centre

Exporters know that if they can get cheaper or different teas from other destinations they can add value and re-export using the advantages they have built in the country. In some ways they are the victims of their own success.

By creating conditions for bulk Ceylon teas to be in high demand through fast-to-market and other services, they cannot easily compete in the retail market with others who have access to cheaper teas.

Exporters want to import tea so that they can have the same competitive edge as other international players. There are also many types of tea, not just Ceylon tea that people consume. All those different types of tea could be supplied from Sri Lanka if imports are freed.

Companies like Dilmah oppose the import of tea – Dilmah itself is an importer of some teas – saying that it will harm Sri Lanka. One argument of those opposing tea imports is that the Ceylon Tea brand will be hurt.

Fear has also been struck in farmers that imports will hit prices in Colombo. These are the same farmers who were hit with export taxes, harming their incomes. Farmers do not seem to understand international trade.

But then they need not understand it. If they can deliver what the exporter communicates through the prices in the auctions, that is all they should be able to do, to do their job harmlessly.

If tea is blended in say Dubai (with good shipping connections) – the Jakarta or Indian or African tea will go there anyway and be blended with or without Ceylon tea. Shifting the blending centre to Sri Lanka does not increase or decrease the total demand for Ceylon tea in the world.

Bulk Exports

The triump of the tea exporter is not whether they sell value added tea or not. The success of the exporter is in creating a market for tea in excess of local demand. It is not relevant whether value is added or not. Adding value is a separate business which could be done with local or imported materials in any good: tea, textiles, rubber, sheet metal, or otherwise.

Sri Lanka now imports rubber for solid tyre manufacture. Has that reduced our raw rubber prices? Like tea, raw rubber prices are higher in Sri Lanka than in some East Asian nations.

Exporters of bulk tea provide a strong demand and a good price for the tea farmer. A branded exporter will not give a higher price to farmers than a bulk exporter. Both will pay the same price. It is irrelevant to the farmer whether the produce is exported in bulk or not.

The same can be said of the cinnamon exporter or the rubber exporter. By exporting in bulk form or whatever form, exporters give farmers a price equall to or higher than the general international price. To get a higher than international price something special must be given, quality is also a key aspect.

While cinnamon exporters were successfully exporting without causing any harm, poor people’s money is being used to support the price of rice with government buy back schemes. Consumers are also being asked to pay a higher price to feed themselves. Billion of rupees are being spent to buy store and throw, or give away rice.

The curent administration has also extended subsdies to rubber and tea producers for the first time.

Packaging and retailing or branding is not the business of the farmer. If they want to do it, it is fine, but they are already working hard, running risks, producing the basic material. As long as they produce a good to an international quality standard they should be left alone to carry out their work peacefully.

Unlike the politicially savvy rice farmers, who cannot produce rice to the international qualtiy, cinnamon producers are not a burden to society to be harmed by export taxes.

Cinnamon Farmers’ Crime

But cinnamon farmers are an easy target and they have been hit by export taxes. They are being hit by export taxes because they produce a quality product, which is not unsaleable abroad, unlike the produce of rice farmers, and is being exported in raw form.

Their crime seems to be to grow an exportable product.

Rice farmers come to Colombo in loin cloth demanding fertilizer subsidies. They are protected through import duties. There is a surplus but that cannot be exported and it is rottign away in warehouses. Thai, Pakistani and Vietnamese farmers are producing better quality, cheaper rice which are being exported by traders.

Imagine an export tax on rice farmers. Why can’t the coercive power of the state be used against them? What will the political repercussion be? But the cinnamon farmers are suffering an export tax and their arguments have been swept aside.

If the export price of a spice is say 1000 rupees a kilo and the tax is 100 rupees, the domestic price of the spice will fall to 900 rupees after the tax is imposed. How does that happen? That is because other countries will continue to offer the product at 1000 rupees a kilo and Sri Lanka’s export price will now be the 900 rupees plus 100 export tax.

The profits lost by the farmer will go as profits for an exporter of a ‘value added product’ that is exempt from the tax. The government or the the government agency that collects the tax will also gain at the expense of the farmer when the bulk product is exported.

Government agencies that benefit from export taxes also have a vested interest in keeping the tax going.

However if the country that taxes producers has a large market share, it is possible that at least part of the increase can be passed on to foreign buyers. it is perhaps possible to sell the product at say 1050 or even 1,100 rupees a kilo for a time.

Export tax that killed Cinnamon

However the danger of export taxes is that over time, the farmers in the export nation will lose market share. Because there are less profits, the decline in the farmed area will also accelerate.

Farmers or their sons will move to alternative areas faster, where there are no interventions from the state like export taxes to discourage them. There are very many industries where subsidies and tax breaks are given.

It is unfortunate that cinnamon is being hit with export taxes again. Ceylon Cinnamon in fact is a classic exmple of how export taxes destroyed an entire sector.

The Mercantilist Dutch East India Company (VOC) and British East India Company controlled the price and supply of cinnamon and a number of other commodities in Ceylon during colonial rule.

But being classic Mercantilist private firms operating with state backing to control the market, they kept prices high, but not too high to allow alternative products to provide too much competition. In addition their operations were not limited to Ceylon.

In the 18th and early 19th centuries, exports taxes were common in all countries and trade was not free.

When free trade swept British empire in the first half of the 19th century and preferences to colonial produce were dismantled pushing the living standards of all people up, export taxes were no longer possible to the extent that it was in the past.

As the cinnamon monopoly was abolished in the 1830s in Ceylon, the British Treasury slapped a three shillings a pound export tax on cinnamon. Unlike the Mercantilists the bureaucrats did not have a full grasp of business just like present day buraucrats.

The tax had "the most disasterous consequences for it quickly made the island’s cinnamon practically uncompetitive in foreign markets," notes historian K M de Silva in his work ‘A History of Ceylon’.

Pressure from the colonial government in the island led to periodic reductions in the export tax and it was eventually abolished in 1855.

"But every reduction had failed to make cinnamon competitive with cassia (casia lignea), a cheap substitute which was capturing an increasing share of the market," notes de Silva.

"Every reduction in duty had come too late. "

During the time coffee was very profitable and cinnamon never regained its former position. The present day tax may not be as high, and the effects will not be as noticeable immediately.

But there are much better alternatives than growing spices or coffee now. Tourism for example.

Cinnamon peelers are already in short supply. The way peelers are paid in Sri Lanka, they may be among those who are paying the export tax to the state or the value added producer. The tax will only speed up the demise of the industry.

Some amazing examples have been given to continue the cinnamon tax. That there is not enough land in SriLanka for example. If there is not enough land, an export tax to improve value added production will only reduce the acreage under cultivation over time.

Another reason given is that if value added cinnamon is increased, Sri Lanka could import spices and re-export them earning more money. But what if farmers who are oppressed by the export tax are then frightened by someone like Dilmah and they oppose imports like in tea? In any case they will not get a fair price until the export tax is removed.

Freedom

A key argument to free imports of tea however is not whether large volumes of money could be made by using Sri Lanka’s blending talent, shipping connections and export expertise to best advantage.

A key argument is to allow Sri Lankans, in what is now a tea drinking country to consume whatever tea they want. The sad situation is that in some areas the people of Sri Lanka are less free that they were in the latter part of British rule.

Many of the trade controls and monopolies set up by the VOC was dismantled by William Colebrook.

It is sad that much worse controls were imposed on the people of Sri Lanka by native rulers who got hold of the taxation, police and prison systems from the Britishers.

Sri Lanka did not get indendence or freedom in 1948. Sri Lanka got self-determination. Companies like Dilmah are using that self-determination to control the basic trade freedoms of citizens as well as people who want to blend.

These type of controls has made the people of Sri Lanka lag behind other countries and suffer lower living standards.

Countries like Vietnam are progressing now because they have and are dismantling controls imposed during the communist era which brought the country to its knees by the mid 1980s.

Vietnam is a producer and exporter of tea. Dilmah is a large brand in Vietnam. Sri Lankans still do not have the same freedoms that Vietnamese people have to drink foreign teas.

Vietnam’s strong point is coffee. Last year, they exported 3.5 billion dollars of coffee. Unlike our branded producers, Vietnamese firms do not whine against imports.

Trung Nguyen Coffee, founded in the mid 1990s from apparently the top of a bycle is a 200-300 million dollar business group. Its owner, Dang Le Nguyen Vu, was unfazed when Starbucks entered the country and jokingly said the foreign product was like chemicals mixed with water. Nestle is already in Vietnam.

Nguyen Vu did not ask the government to tie the hands of the people behind their back with an import duty to protect his business interests. In fact the lack of vested private business to oppose trade freedoms given to poor Vietnamese when the country liberalized to enter ASEAN was a key reason for the rising living standards and export competitiveness of Vietnam.

It is not necessary to oppress consumers in the home market to succeed abroad. There is no real link between the two. If a brand is pleasing the customer competitively it is not necessary to rob the freedom of domestic consumers.

The T2 tea brand in Australia which was bought by Unilever a couple of years ago is a good example of a how brands can be built in a few years without oppressing anyone.

But premium products are not necessarily what made the poor rich and transformed the world. It is mass market products that changed the world. Luxury products, were also available in the fedual era but did not do anything much. The bigggest impact on the domestic tea market in Sri Lanka in recent years had been made by Watawala tea for example, which has a lower price point than the firm’s first brand, Zesta.

Going after ‘geographical indicators’ with legal power and coercion will not do all that much good either.

French wine producers are trying to limit the use of the word Champagne through laws. But Champaign was a ‘defective’ wine that made bottles explode when ‘higher quality’ still wine did not bubble. Like the people who originally made Ceylon Tea famous, it was British free trading importers who were partly responsible for making Champagne and sparkling wine into a popular product from a defective one. It was British glassmakers who in fact made bottles strong enough to withstand the pressure.

Despite the nationalism of geographical indicators and appelleation, France is a major consumer as well as a top exporter of wine. It also imports wine, especially from California and Chile among other places. A key export destination of Californian wine is France.

France imported 644 million litres of wine in 2014, up 22 percent from a year earlier.

In addition there is a large volume of bulk wine being traded now for blending near home markets. It seems global supply chains are taking over the wine industry as well. In 2014 about 56 percent of wine imported to the EU was in bulk for blending and about 42 percent of intra-EU trade was also in bulk form.

Profitting from oppresion or nationalism is not the way to go. The time for that is over. Mercantilism should have died with the British East India Company. Free trade and free enterprise capitalism brought much more benefits to the poor than Mercantilism ever did. Its revival and robbing freedoms is not progress.

This column is based on ‘The Price Signal by Bellwether‘ published in the January 2016 issue of the Echelon Magazine. To read Bellwether columns as soon as they are published, subscribe to Echelon Magazine at this link. The i-tunes app can be downloaded from here.