Sri Lanka needs stable liberal policies, property rights, to get export oriented FDI: economist

ECONOMYNEXT – Sri Lanka should have a stable liberal policy framework with free trade and strong property rights to draw foreign direct investors who will build East Asian-style global production networks, a top trade economist has said.

To attract foreign investors into merchandise exports, concurrent trade and investment liberalisation is needed, Prema-Chandra Athukorala, professor of economics at Australia National University’s Crawford School of Public Policy, said in Colombo.

Concurrent Freedoms

"Global production sharing requires concurrent liberalization of trade and foreign direct investment policy regimes," Athukorala told a forum organized by Advocata Institute, a free market think tank based in Colombo.

"FDI and trade policies are co-determinants of the location of choice for multi-national enterprises within production networks."

India had failed to become part of global production networks, he said though investments were liberalized from the 1990s.

About two third of merchandise exports now involve global production sharing, he said.

East Asia’s export growth is being driven by foreign investors who built global production networks, where components are built in multiple countries for final assembly in a third country,

He said import duties of a country has to be low and preferably a single rate as high, multiple and cascading taxes reduced revenues and made the regime complex.

Liberal investment and trade policies have to be consistent, Athukorala said. Even if government’s changed policies have to remain.





Freedoms taken away

Though Sri Lanka was one of the first countries in Asia to give trade and investment freedoms, and companies like Motorola and Intel were about to come to the country when civil war broke out.

Over the past few years, freedoms have been taken away from the people in ‘policy backsliding’.

In addition to trade restrictions, an expropriation law, which undermined property right was negative for investments, Athukorala said

When Sri Lanka liberalized in the late seventies a constitutional guarantee was given against expropriation. But firms were expropriated despite that.

No compensation had yet been paid even to shareholders of two listed companies that were nationalised by the Rajapaksa regime.

Property rights and the ability to enforce contracts were key determinants to draw foreign direct investments to boost exports, he said.

Buyer vs Producer driven GPNs

Athukorala identified two main types of global production networks, driven by buyers and producers.

Apparel, travel goods, footwear, toys and furniture tended to be buyer driven, where producers in developing countries were part of a chain where arms-length transactions were possible.

Joint ventures were common but not always necessary.

Producer driven GPN mostly involved electronics, electrical goods, automobiles, scientific equipment and medical devices.

The bulk of activity involved a ‘lead firm’ with subsidiaries. But over time subcontractors in host countries became part of the network and even provided their own technology.

Logistics and infrastructure were key, he said. For hi tech electronics manufacture air links were crucial.

Cheap Labour

Mere cheap labour did not draw GPNs to a country, he said. Without trade and investment freedoms which were consistent and good infrastructure it was not possible to operate global production networks.

Athukorala said despite the abundance of cheap about, Africa failed to draw GPNs.

Even Indonesia, which had cheaper labour, did not draw as much manufacturing FDI as other East Asian nations, Athukorala said due to the lack of other attributes.

However labour had to be abundant. Manufacturing exports makes it easy to train low skilled workers.

Though Sri Lanka did not have large pools of labour for final assembly like Vietnam and China, Sri Lanka had enough labour for successful GPN. Areas like Penang in Malaysia had succeeded in drawing hi-tech GPN in electronics.

In Penang foreign firms were engaged in research and development, with intellectual property protected with loyal employees, Athukorala said.

There were fears of technology leakage in China, where firms did not do innovation and adaptive work, he said.

Unsound Money

Some analysts also say that Indonesia and the Philippines also have the worst central banks in the region, where the currencies have depreciated steadily.

Unsound money does not promote stable economic conditions, and falling real wages can create labour unrest political instability.

Singapore has a modified currency board with no active policy rate. Hong Kong has an orthodox currency board (hard peg with no money printing at all, where the exchange rate has been fixed since 1982. So do Brunei and Macau, giving freedom from excessive inflation and currency depreciation. Others have pegs of varied success. Korea has a near-floating rate after the East Asian crisis.

Weak currencies in Indonesia and Philippines (along with Sri Lanka) had led to massive labour migration to the Middle East or other East Asian countries with sounder money (stronger currencies) like Malaysia or Korea.

Many of the stable Middle Eastern countries including UAE and Saudi Arabia have near-hard pegs with no interventionist policy rates maintained with printed money but instead mimic US rates to maintain stable exchange rates, in a currency-board-like manner.

Currency depreciation destroys real capital (bank savings, pension funds) while countries with strong currencies have more domestic real capital to invest in manufacturing, or services generating labour shortages and imports of workers.

Sound money also raises domestic living standards also promote domestic demand, by giving citizens freedom from inflation and currency depreciation which are indirect exporpriations of their wealth and salaries.

Unsound money and a false belief in currency depreciation to maintain competiveness – essentially a device to cut real salaries and make workers poorer with higher inflation – may also point to the existence of other bad policies and false doctrines, overall, critics say.

Signal to investors

Goh Keng Swee, Singapore’s first Finance Minister, a key architect of the country’s transformation, made sure that the money was sound and a currency board inherited from the British was kept.

He refused to build a central bank credit (printed money) and manipulate rates, fill budget deficits and generate currency troubles.

"Our economy was and is both small and open," he said later explaining why a central bank was not built in post-independent Singapore.

"Financing budget deficits through Central Bank credit creation appeared to us as an invitation to disaster.

"There was no effective way of exchange control in an open trading economy like ours to deal with the inevitable balance of payments troubles."

A strong currency while balance of payments troubles also helped signal investors, he said.

It would inform the "financial world that our objective was to maintain a strong convertible Singaporean Dollar," Goh said.

"This remains the best protection against inflation.

"When nearly two-thirds of our citizens’ expenditure is spent on imported goods, a strong Singapore Dollar helps to keep consumer prices down.

"The second purpose was to inform our citizens that if they wanted more and better services, they must pay for these through taxes and fees. There is no free lunch here." (Colombo/Aug20/2016)

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