ETCA is being played very badly politically – Prof. Razeen sally

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By 2017-06-19

By Umesh Moramudali and Rathindra Kuruwita

In recent past there has been a lot of discussion about the National Trade Policy. In the light of trade policy discussion, Ceylon Today interviewed Prof Razeen Sally who is Associate Professor at the Lee Kuan Yew School of Public Policy at the National University of Singapore. Prof. Sally is also the Chairman of the Institute of Policy Studies (IPS), the main economic-policy think tank in his native Sri Lanka.

Following are the excerpts of the interview:

?: The National Trade Policy is a popular topic in economic circles these days. As an academic who has studied the international trade thoroughly how do you see the importance of the trade policy and which direction it should go?

A: It is very important for sustainable growth based on productivity gains which Sri Lanka did not have for some time. It refers to a combination of domestic private investment and trade led growth. Trade policy reforms are crucial in that sense. However, these reforms need to be seen as a part of the national competitiveness strategy. Therefore, there has to be domestic reforms linked to the trade policy reforms. It is a mistake to think that trade reforms is isolated; instead those have to be backed by domestic business reforms.

So Sri Lanka needs to think of increase of private investment and more trade integration. Unless, we see increase of imports it is hard to think of increase of exports. We need to see more export competitiveness from domestic companies, but that is not sufficient. We need foreign investments; also foreign investments linked to exports and connect Sri Lanka to global value chains beyond garments.

?: Thus far, it is observed that the discussion on trade policy is dominated by Free Trade Agreements (FTAs). Recently, another trade expert, Prof. Prema Chandra Athukorala too raised concerns about this. What is your take on that?

A: I agree. It's a common mistake to think that FTAs are the primary solution. It's a very narrow view of how trade works. It's a very mercantilist view of trade in which emphasize is given to exchanging export concessions. Most important reforms are unilateral reforms. So that the government goes for trade reforms for the benefit of the country in non discriminatory way. Trade negotiations and trade agreements, the sensible ones, can be supported within such unilateral reforms. My view is that we should focus on unilateral reforms and as a compliment to that you can reinforce it with FTAs along with the rules of the WTO. But it should not be done the other way around. If you do so, you allow the external forces and narrow mercantilism to dictate the ship of your trade policy. Then you end up with something more partial and forgo the benefit that could be gain through wider trade opening through unilateral reforms.

That's my take and my advice for the government. However, what happens is the complete opposite of it. The government hasn't really had a plan for national trade reforms and no action on that front and national trade policy is led by three FTAs with China, India and Singapore. China and India are big markets and that is one argument to justify the action. Singapore is a much smaller market, but easy to do an FTA with as it is an open market. Also that could be a testing ground for negotiations.

But none of these negotiations will trigger serious changes in the national trade policy in the way the economy works. Because this seems the be all and end all of the trade policy, and many see this a serving interests of bigger countries. So it ends up being politically counterproductive as well.

?: One of the biggest challenges encountered when the trade is liberalized is the risk of losing tax revenue given that nearly 25 per cent of tax revenue is raised trough taxes on external trade. How do we tackle this issue if we liberalize the trade further?

A: It's an important short term issue given how weak the tax base. Answer for that is not to stay away from liberalizing trade. We need to go ahead with modesty. There needs to be transition period to seek for alternative methods to raise tax revenue. During such period we can think of easing the burden.

My view is that we need to set up sensible targets in terms of trade reforms. To be more precise, targets about tariff as well as para tariffs should be set and the government needs to think about sensible transitional periods. However, such transitional periods should not be too long and during such period the government can work on reform tax base.

That should be the principle of policy. During transitional period the government can move to two bands of tariff and move toa single uniform tariff later.

Lessons from countries that have significantly liberalized trade with more modest and simpler import tariff shows that revenue has increased when the trade was liberalized and tariff structure was simplified. The reason is that the new tariff structure had encouraged black market and that has pushed companies to pay tariff. So losing revenue is a short term excuse, but it should not be an excuse to stay away from reforms.

?: You talked about increasing the national competitiveness. In your view, how should that be done?

A: It's a long list starting with simpler reforms to complicated ones. Sensible way to do that is think of priorities and do what politically realistic.

We need to have more flexible labour market, more flexible hiring and firing policies, make it easy to buy lands for foreigners in the country, sensible tax system, and more liberal rules for foreign workers particularly for professionals, downsized public sector and many more. We know that none of those are going to happen within the tenure of this government. It is not politically realistic even if the political will were there.

On this list I will include, trade reforms too including incentives for foreigners to come and do business here. By incentives, I do not mean tax incentives.

We need kind of reforms that would enhance the rank of ease of doing business index. In last three years, SL's rank has dropped down. We need to bring reforms that enhance the business climate for the foreign as well as domestic businessmen to invest.

On the top of that we need to simplify the licencing process. That can be done by having one stop shop and enhance the online presence. It is important to have short deadlines. Many countries have done this and we can do it. These were talked about, but not done.

?: You mentioned about free movement of labour. When we talk about free labour movement, what comes to mind is Economic and Technology Corporation (ETCA). How politically feasible is ETCA given the strong resistance to that?

A: At the moment it's politically difficult. It was made more difficult given the way it is done. If it was a part of a national reform strategy, rather than something left to a trade negation with the biggest neighbour it might have been more feasible. But it is being played very badly politically as it was left to trade negations. Interest groups had ringed alarmed bells and such were not countered by the government. So it seems that the interest groups had won the debate by default. That also makes the government defensive and says we are not going to sign any of this in the agreement. This may be an issue to be left to later.

Simple because the political capital spending on the matter would be too costly and there are many other battles to fight.

So as a political trade off I might leave that for later. However, things like moving to one stop shop and automate custom procedure, are modest in comparison with a concern like ETCA for which interest groups which are politically powerful. So this is a matter of politically judgment. One has to be realistic, yet one can't make a good start if there is no concrete plan and broad vision along with political will to push opposition and inform the public. All of these are missing.

?: There are suggested reforms such as implementing single window and setting up EXIM Bank. These are not objected by interested groups. Why are such reforms getting delayed even in the absence of the resistance?

A: Well. Of course there are people in government who have strong interest in maintaining status quo. It's true of custom officials, politicians who have businesses who gain advantage due to the existing close door mechanism and then we have dysfunctional machinery of government. It boils down to the will of top most decisions to cut through these tickets and get things done, that has been lacking

I mention the machinery of government. Whatever reforms you need to act up on you need a mechanism to get these things implemented. You need right people at the right place. That again has not happened. Under the previous government, there was a pyramid structure under which certain things, things that mattered to the Rajapaksa family were implemented as the decision making was centralized.

With this government it is the other extreme. It seems to be a very plural free flow with no sense of implementation. Many people are involved in decision making and they are acting in different directions blocking each other and there is no real coordination mechanism and there is no sense of prioritizing. Many of the people involved in these are not equipped for the job.

?: Sri Lanka has entered into few FTAs. While the country having bilateral trade agreements with India and Pakistan, there is South Asia Free Trade Agreement (SAFTA). In your view, what exactly is the role of SAFTA?

A: it's a talking show and a very weak agreement. The strongest trade agreement we have is ISFTA. That too is weak in terms of international standards. It may be strong in terms of South Asian standards, but certainly weak in terms of international standards.

It is just about trading goods and there are many NTBs. It has big loopholes in terms of ROO. So I certainly would count on ISFTA, SAFTA and PSFTA.

I would not count on ETCA either. Given the politics of it, it seems a weak agreement. Indians do not negotiate strong agreements in any case. I have few hopes on the South Asia part.

The reason why there is no South Asian economic integration is the lack of India leadership. India is 80 per cent of South Asian GDP. As long as India does not prioritize SAFTA, does not lead by example, SAFTA is not going to be serious. So I would not wait for SAFTA or would not depend on that.

?: Sri Lanka faces to Balance of Payment (BOP) crises time to time. Do you think that import substitution up to a certain extent is a solution to this?

A: No. I don't think so. This was a fashionable view to deal with the BOP crisis after great depression till 1970's. It might be a short term macroeconomic fix. But of course it does not address the competitiveness in Sri Lanka. It will take the country backwards. Any kind of Import substitution will undermine the competitiveness of the country.

Trade and current account deficits are macroeconomic phenomena. It is shown in theory and has been proven. Its matter of saving and investment in the economy, hence the importance is on national competitiveness. Structural solution to BOP crisis is to address the issues at its source. Therefore, the emphasize should be on structural reforms relating to savings and investments.

If you try to plug the BOP crisis through import substitution you are doing a few things. First you will reduce exports, which was not understood by many interested groups. They think we can increase exports while reducing imports. As proved by Learner Symmetry Theorem, there exists a correlation, a positive one between imports and exports, particularly in global value chains where you need imports to produce exports. When imports go down, export goes down.

When import substitution policies are implemented, you are shifting domestic resource allocation to the domestic non-tradable goods which reduce exports competitiveness.

When you impose import substitution, it will create incentives to produce and consume domestic non-tradable goods as opposed to producing tradable goods and services. Then you have to think about the overlay of import substitution as well. Any kind of import substitution create vested interest that block liberalization down the line.

For all these reasons I think it is the wrong way to go. If you have a problem, you should address it at its source. That is the most economically efficient way to go ahead and the problems of its sources are domestic problem and that should be dealt using domestic reforms and using trade reforms for such is not economically efficient.

?: Yet, Japan continues to practice import substitution in the rice industry, and does well in terms of trade. You think that is an exception?

A: They are. Japanese agriculture protection is very high, it is high in most developed countries. But we need to keep in mind that agriculture is only 2-3 per cent from the GDP and it employs tiny part of the labour force. On the other hand, Japanese economy is fairly open. Japan is a country that has one of the lowest tariffs in the world. Bulk of the economy dominated by manufacturing and services are open. So when you have an open economy in most of the industries, you are allowed to protect certain industries.

SL is comparatively a closer economy comparing with other countries. Hence we are not talking about further closing it.

?: Don't you think that we have a fairly open economy comparing to other countries in the South Asian region?

A: We did. That gap has narrowed quite a bit, we are the one which initiate the opened economy. But do not forget that during the last regime we closed the economy. It is true that we have a more open economy than India. But India is a bigger market, as a result of that investors willing to invest more in India as the market base is high. It's no longer a closer cut to say that Sri Lanka is the most open economy in South Asia which in any case does not say much.

Umesh and Rathindra can be contacted via [email protected] and [email protected]

 

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