Optimizing investment by public and private sectors:

Link for growth and prosperity

Presented by Lalith de Mel at the 2009 CIMA Business Leaders' Summit

Presented by Lalith de Mel at the 2009 CIMA Business Leaders’ Summit

Growth is a function of investment. If there is growth it can lead to prosperity. If there is no investment we will not have growth or prosperity. That succinctly sums up the vital role of investment. Any economic model for Sri Lanka will require investment from the private sector and the public sector.

To grasp the nature of the link between the two sectors we must seek the answers to three questions.

* How do you generate investment?

* Will the behaviour of the public sector have any impact on investment by the private sector?

* Will the behaviour of the private sector influence investment by the public sector?

The answers to these three questions will reveal the link between the private sector and the public sector and growth and prosperity. To develop any economic model that will deliver these twin objectives, it is essential to grasp the full nature of the interrelationship between the two sectors so as to optimise investment by both sectors.

The single most important factor that influences investment by the private sector is their view of the future. Is it blue skies or grey clouds? Private sector investment decisions are driven primarily by the expected returns on investment. The investment takes place today but the returns depend on what happens tomorrow. The longer the gestation period of an investment - the greater the concern about the future, because the investor has to take a view about the long term prospects of his investment.

Private sector

The private sector in Sri Lanka tends to view the Government and its executive arm the public sector as the owners and controllers of the economy both in the short term and the long term. Therefore, the public sector has a large role to play in creating confidence about the future.

If it fails to do so it will affect adversely investment by the private sector which will then impact on growth and the creation of prosperity. The Government has many levers to manipulate and buttons to press to manage the economy. What they do is very visible to the pubic. If they appear to be hitting the right buttons it can create confidence. if they are not pushing the correct buttons, it will create diffidence and uncertainty about the future.

The public sector through the Finance Ministry and the Central Bank have to manage effectively the Budget deficit, the money supply, the foreign reserves, the movements in Government borrowing, debt servicing and of course the financial budget of the country. Of all the levers they control the outcome that is most visible and of the greatest concern are the short term rates of interest.

If the rates of interest are in the 20s the private sector investor will come to the correct conclusion that you cannot borrow at 20+ percent and get a return as the investment will have to provide returns greater than 20 percent for the investment to be viable.

There are not many opportunities to get returns above 20 percent. The officials of the public sector have to manage the numbers (no doubt under some guidelines from the relevant Ministers) and that creates the visible tangible picture that creates confidence or uncertainty. The less tangible, but no less important are the impressions created by politicians.

The politicians are not strictly public sector. They are the legislature that creates the laws that regulate activity in the country. However, the ruling party in power often behaves as if they are the owners of the public sector. This casts a burden on them.

Influence thinking

They can influence thinking in either direction. Their words and body language can create optimism. They can also create a vision of uncertainty, if they do not counter the views of the politicians in the opposition, who, as a way of life peddle the doom and gloom scenario.

Public sector spending on the services it has to provide and its expenditure on building the infrastructure for the future is dependent on the revenue available. Its principal source of revenue is the taxes paid by the private sector. Because of this the view of the future and the implications that flow from it are not solely relevant to the private sector.

If the private sector sees grey skies and takes a dim view of the future and there is no incremental investment and no economic growth, it will result in no incremental taxable income that will provide incremental tax revenues for the state. Without an increase in tax revenues the State cannot invest in new projects that will create growth. So the link between the two is significant as the public sector is materially affected by what the private sector does or does not do in terms of new activities that will generate tax revenues for the state.

Macro picture

That is the macro picture of the impact of blue skies or grey clouds on investment and growth. When you drill down from the macro to the micro, you get a better perspective of the link between the two sectors and investment and growth. The starting points is to build the profile of the economy and to probe the links pertaining to the various segments of the economy.

Sri Lanka is basically a private sector owned economy. The private sector is not only the big firms in the big Chamber. They are more visible as the big players' photographs are in the newspapers and their wives are regularly in society magazines. In fact they are the smaller part of the private sector. There are large private firms, probably in totality larger than the Chamber firms. Beyond that there is a huge private sector.

All the tea and rubber small-holders who are the larger part of these industries, the coconut and spice industry, the fishing industry, the entire retail network, all the paddy farming and other agricultural products and a huge variety of small manufacturing firms ranging from handicrafts and jewellery to every other conceivable thing. They are all private sector. There is a huge people's private sector.

The picture that emerges is that Sri Lanka is a private sector owned economy. This private sector has almost complete freedom to do whatever it wants, as very few sectors are reserved exclusively for the public sector. The private sector can build houses, hotels, start new industries or new businesses and grow new crops. But behind this facade of complete freedom there is a nasty ogre lurking in the wings. Sri Lanka is a private sector economy that is being strangled by the public sector.

This is not due to some political philosophy. The public sector is not riddled with old fashioned Marxist commies dedicated to the cause of destroying the private sector. The genesis of the strangler is complex. We had and have a very high level of literacy. This is now basically in the national languages. On top of this mountain of literacy we have a layer of rich cream of highly intelligent, western educated, English speaking people.

They have dominated the leadership in many spheres, they were probably the movers in creating a mass of what will generally be called good legislation. It is perceived to be good because highly developed western countries have such legislation, and they are all meant to preserve the country and its heritage. But there are difficult questions.

Are they relevant? Do we have the people skills to make them work in a sensible manner? Will it open the jam jar of corruption? Will it be a great hindrance to investment? Sadly we cannot tick all the right boxes in relation to these issues. I will argue that this good legislation as it is currently framed is bad news and a great impediment to economic progress. Therefore, I will refer to all this legislation collectively as the strangler. It is interesting to probe carefully how the entrepreneur bursting with enthusiasm to invest encounters the strangler.

Hypothetical case history

The sage of the entrepreneur versus the strangler will be explored through a hypothetical case history of an entrepreneur who wants to build a beach hotel. The first step is to get the title deeds and survey plans accepted by the Pradeshiya Sabha. They will not do so until the coast conservation authority surveys the land and marks out the area on which they cannot build. That is 50 metres from the shore. But what is the shore, where does it begin? Even this first step is not straight forward and will take many weeks.

The Pradeshiya Sabha after approving the site will not approve building plans until a whole host of other approvals are obtained. That is when the fun starts. Let's take a closer look at all the other approvals that are required. The Prospective hotelier needs approval under the Tea, Rubber and Coconut Fragmentation Act, even if there is one withered coconut tree in sight, and the site was a part of a larger estate at some stage in the past. Approval is required from the Forest Department to confirm that it is not a part of a forest reserve even though there is no visible forest within 100 kilometres.

Not in a wild life sanctuary

The Wildlife Department has to confirm that it is not in a wild life sanctuary. The Antiquities Ordinance requires that confirmation is obtained from the Archaeology Department that there are no historically significant antiquities buried under the site. The list of laws that impact goes on and on.

Environment, Road Development, Low Lying Land Reclamation, Railway if there is a railway line in the vicinity etc.

The final step is the Urban Development Authority for approval of the building plans, a task that gets devolved on the Local Authority of the area. There is one classic case history where all the approvals had been obtained and no defect was identified in the building plans but the Kotte Municipal Council who had the delegated powers of the UDA to approve them just would not grant approval and gave no reasons for their refusal. The reason was a rather parochial local political issue.

Not much purpose in going any further into this, but it illustrates well the total power that various authorities have to say no and they can be indifferent to the consequences. The project they refused to approve was a BOI approved project with 100 percent foreign investment the land was provided by the BoI who considered this a major break-through project for the country. It was the HSBC call centre. It was finally approved through political intervention.

The Board of Investment gets criticized severely for not being a one stop shop (and for pretending to be one). The BOI experience is very revealing and it is helpful to unravel the strangler through their experience.

The BOI is one stop for granting approval for a project with foreign investment and for granting the tax holiday concessions and the duty waivers as applicable. It is also one stop for providing land, from their land bank. The investor armed with all of this finds that he cannot start his project without all the other approvals.

The bemused and agitated investor storms into the BOI and asks them to get these approvals. But the BOI is helpless as it has no power whatsoever to instruct the independent agencies (the strangler) to grant approval.

All that the BOI can do is to organize monthly meetings and to ask these agencies to expedite the process of granting approvals. Invariably nothing has happened when the next monthly meeting comes along.

To be continued