_Goliya tharangaye kakul bandapu asvayo_

h3. Introduction

My purpose in this presentation is to show what the government should and should not do in facilitating participation by Sri Lankans in the global economy. I will begin by situating this island nation and its people in the global economy, arguing that we are already globalized and that we have little option but to play in the global economy as best as we can. The option of withdrawing to some mythical state of self sufficiency does not exist, and did not exist even when the SLFP-led governments tried to take us there in the past. Then I will use a concrete example of services exports to show what should and should not be done by governments. I will show that the primary responsibility of government lies in creating the conditions for efficient supply of infrastructure services and education. Finally, I will connect these arguments to Professor Kornai’s writings, especially his discussion of private property rights and the necessity of a non-distorted price system.

h3. Sri Lanka in the global economy

Analysis must begin from a realistic assessment of where we are and what we are. We are a small island nation in South Asia, a region that is home to the world’s largest concentration of poor people. We are about the size of Greater Mumbai, one urban agglomeration in India, in population and we are smaller than Greater Mumbai as a market. Despite a per capita GDP that is higher than all our South Asian peers save Maldives, we are less developed than India and Pakistan. We do not have significant natural resources to use or to export; our agricultural products are not lowest cost, though the people who produce them are rewarded very poorly. We do not have a significant industrial base; our biggest industry is apparel, which is heavily dependent on quotas and in trouble with the end of quotas in 2005. Our future lies in services, a sector of the economy that is even now the largest. We have been exporting low-value-addition services such as housemaid services to the Middle East and East Asia; and these poor people have been keeping the economy afloat. We must move to higher-value-added services if we are to prosper.

Sri Lanka is already highly globalized. Around two million of our people live abroad: most temporarily and many separated from their families. The ratio of exports plus imports to the GDP is around 75 per cent, which makes us heavily trade dependent. Most of our exports go to the United States, on the other side of the world. We are more liberal than our peers with regard to international trade. Seventy per cent of the containers going through the Port of Colombo are transshipped. Increasingly, that pattern is beginning to appear with regard to air passenger transport as well. Or we hope it will, following the opening of the India-Sri Lanka air services market by Prime Ministers Vajpayee and Wickremesinghe in October 2003. We have fewer foreign investment barriers than any of our neighbors. Many foreign investors are already present in Sri Lanka.

Given the nature of our economy, we cannot not import. Our agriculture depends on imports of fertilizer, chemicals and fuel for tractors. The textiles and the sewing machines for our apparel industry come from abroad. The tourist industry cannot function without imports ranging from kitchen equipment to toilet paper. The paper for the exercise books that our children use in school comes from abroad. Self-sufficiency is no longer a policy objective in India and China, continental economies that once pursued that goal; or even in Vietnam, still a Communist-ruled country. It was never a realistic strategy for an island economy like ours. Even in the Anuradhapura period we were importing and exporting, though of course on a different scale. It is only in the dark times of the drift to the Southwest that we were self-sufficient, and poor.

We import; therefore we must export. Wealth creation and job creation in Sri Lanka depend on exports. We can continue to export agricultural products, but that’s a difficult path because we are not the lowest-cost producers. Vietnam and Kenya can sell tea for less than it costs to produce it here; our rice costs a lot more to produce than the prices of imports from Vietnam; and there is really no mass market for the varieties of rice that we produce. What the world wants is long grain and basmati; what we produce is samba, kekulu, etc. For the companies that add value to rubber, it is now cheaper to import rubber than to use local raw material. We can be successful exporters only if we create and exploit niches, where higher quality can sustain higher prices. The story is no different in industry. What this means is that rapid wealth creation and employment generation rests on the services sector, as has been shown quarter after quarter where growth in telecom and banking pull the economy forward. Agricultural and industrial exports can and should be encouraged, but the engine that will take us out of poverty is service exports.

Those who study trade in services talk about four modes of trade:

* Mode 1, wherein the seller remains in country A and the buyer remains in country B. Example is a doctor in India who treats a patient in Sri Lanka, using telecommunications as the medium.
* Mode 2, wherein the seller remains in country A and the buyer comes to Country A. Example is a Sri Lankan heart patient going to the Chennai Apollo Hospital for treatment, or a tourist coming to Sri Lanka to use our hotel services. This requires good infrastructure such as airports and roads in the selling country.
* Mode 3, wherein the seller establishes a commercial presence in country B in order to sell services to the buyer in country B. Example is the establishment of an Apollo Hospital in Colombo.
* Mode 4, where people from country A come to country B to sell services. This can happen with Mode 3. For example, Indian doctors may come to Sri Lanka as part of the effort to provide Apollo quality through the Sri Lankan affiliate. But it can happen without Mode 3 as well, as when Sri Lankans go to the Gulf to supply house-maid services to persons living there.

We export services in all these modes today, mostly Mode 4. In order to improve the work conditions and incomes of our service exporters (by this I do not mean firms, but all who work in these industries), we need to improve the conditions of service supply and trade. This is a responsibility of the government. But it is one that has been neglected because government has tried to do too many things, and ended up doing none well.

h3. Business process outsourcing as an example

Let us take the example of business process outsourcing (BPO). The most familiar example is a call center, where a whole group of people wearing telephone headsets and sitting in front of computer screens answer calls from a firm’s customers on behalf of that firm, using computer based information systems. There are many kinds of BPOs, some that require very high levels of skills. Because it is outsourcing, the service providers are not located in the same place as the firm and are not employees of the firm which is receiving the calls. In some cases, they can be in a different time zone and may be even on a different continent. When this service is provided across national boundaries, it constitutes Mode 1 service trade, conducted using telecommunications: the buyer, for example is in the United States and the seller is located in Sri Lanka. The key elements are the reliance on computer-based information systems, telecommunications, and specialization.

BPO activity started in the late 1980s and early 1990s in the American Midwest, in Ireland and in India. The basic concept is one where the routine, back-office functions are analyzed, reengineered, separated and outsourced to a firm that specializes in providing those services, generally at lower cost and higher quality. Starting with moving back-office functions of New York firms to rural America, BPOs then moved to Ireland, and now are concentrated in India, the Philippines and other parts of Asia. By the late 1990s, India, particularly southern India, had become a major BPO supplier but Sri Lanka, despite its similarities with Southern India and its much talked about high literacy, was left out. It was only in 2004 that Sri Lanka began to attract significant BPO business. The reasons for Sri Lanka missing the BPO bus lie in government action; the reasons for that situation changing in 2004 were also related to government.

In 1997, the then government gave a five-year exclusivity to Sri Lanka Telecom and the Japanese company that won the bid to manage it. This poorly crafted legal commitment was interpreted by the Japanese and the Sri Lankans appointed to manage SLTL as a comprehensive monopoly over international services. Instead of trying to develop international services in ways that would serve the needs of current and future business and residential customers, they spent all their energies on defending this misguided and ambiguous monopoly. The government, for the most part, pandered to this, for reasons unknown. Court cases proliferated instead of new business. Not seeing redundancy in international telecommunications supply, not seeing flexibility in pricing and service options, but only an obdurate and arrogant monopoly, the BPO business passed Sri Lanka by.

It was only in 2003, after the government of Mr Ranil Wickremesinghe decisively ended the SLTL’s exclusivity by issuing licenses without limit, that BPOs started looking at Sri Lanka. The regional resource center being built by HSBC on the side of Parliament Road in Rajagiriya (with BPO workers already serving customers from temporary accommodations) was Sri Lanka’s first high-profile BPO operation. The fact that it obtained its international telecom capacity from VSNL Lanka, a new international operator licensed in 2003, is evidence that telecom supply was a key inhibitor. The positive image created by the peace moves of the Wickremesinghe government was obviously hugely supportive, but that alone cannot explain the absence of BPOs prior to 2003 and their subsequent entry.

What does BPO business mean for Sri Lankans? It means higher wages and working conditions superior to those in government and most private sector offices: air conditioning, exercise and recreation facilities, etc. It can be somewhat repetitious, and does not allow for slacking. Most likely, a young person would not want to spend his or her entire life in the BPO industry especially as an agent answering phones or e-mails, but it provides an excellent foundation for a job elsewhere or for starting a new business. One major limitation is that most BPO jobs require fluency in English. But again, niche applications exist where, for example, accountancy or financial analysis skills matter more than English. In one BPO operation in Kandy, 90 book keepers work on the books of British Financial Accountants, supervised by 5-10 accountants. Because the interface with the UK clients is handled by these supervisors, only they require facility in English.

This kind of Mode 1 services trade, where the buyer and the seller each stay in their own countries, is far superior to Mode 4 trade in services, where the Sri Lankan service providers have to go to the seller’s country to sell their services, in many cases leaving behind their families and suffering various hardships. Mode 1 trade allows the service suppliers to stay close to their families; more of the money they earn is spent where they live, providing more business for others and growth for the overall economy. The articulation of the export industry and the rest of the economy is essential for the management of social conflict that can arise when parts of economy (especially export sectors) accelerate, leaving others behind.

What must government do in this regard? It must, first and foremost, stay out. Interfering and overly regulating does not help. According to the former Minister of IT in India, Mr Pramod Mahajan, India succeeded in beauty and IT, only because those were two areas where the government did not know and therefore did not interfere.

But government can, and should, remove unnecessary barriers. For example, one of the things the government did in 2004 was to exempt the BPO industry from an archaic regulation that required the presence of matrons when women were employed during the night time, and otherwise heavily restricted night-time work. Interestingly, the Communist government of West Bengal went further, more or less banning strikes in the BPO industry by designating it an essential service. BPO customers are in different time zones; in some cases, their day time is our night time; by definition, a BPO firm cannot keep regular Sri Lankan hours. Those who advocate these paternalistic regulations for women workers in Sri Lanka are not only keeping good paying work away from independent young women; they are creating the conditions for those young women to seek work abroad under conditions that are immeasurably worse.

Beyond that, the government’s role is to create the conditions for the supply of efficient infrastructure services and human resources; not to directly supply, but to create the conditions. By infrastructure I mean cheap and reliable electricity; modern and low-cost telecommunications facilities; roads and transport systems that allow for reliable movement of workers and executives; water supplies, and so on. It is not possible for a BPO firm to self-supply most of these essential services and remain competitive. Generally what is required is choice. Multiple suppliers, as in the case of international telecom providers to HSBC, result in low prices and good quality. Government must liberalize infrastructure industries, encourage private supply, and only regulate where essential: “competition wherever possible; regulation where necessary.”

All industries, especially those participating in the global economy, train their workers continually. Lifelong learning and skill upgrading are essential features of work in the globalized economy. Yet, government has a role to play in giving industries a basic level of trained manpower. Again, the responsibility is not that of directly providing, but of creating the conditions for efficient provision. As noted above, one of the key constraints holding back BPO development in Sri Lanka is the dearth of persons fluent in English and comfortable with IT. BPO industries can add a certain level of skills, including things like accent neutralization (so the customers can understand what the service providers are saying), but one cannot realistically expect them to provide the basic English training also.

Now let’s turn to the problem of regional disparity: Kolambata kiri; apata kekiri. It is a fact that the new BPO businesses are being set up in greater Colombo and Kandy; that the young people getting these jobs are from among the already privileged, English-speaking middle class. But this does not have to be. The main reason for export industries clustering around Colombo, despite its exorbitant land prices and rents, its congested roads and the higher wages demanded by workers, is the lack of adequate infrastructure in the rest of the country. The quality of electricity is not very good in Colombo, but still the blackouts and voltage variations are worse in the regions. The fiber optic cables that provide high quality and ultra reliable telecommunications (recall that in the BPO business, a telecom interruption means the cessation of business; and that in some BPO activities, the quality must be such that the customer feels that the service representative is talking from the other side of the street, not the other side of the world), simply do not exist outside the Western and Central provinces, and portions of the Northwestern and Sabaragamuva provinces. Matara, despite being a major commercial and communications center, is still served by microwave links, as is the entire Southern Province.

The Wickremesinghe government of 2001-04, under the direction of the then ICT Minister, Mr Milinda Moragoda, conceived of a solution to this problem that I hope will be implemented without delay and deviation. This is the e Sri Lanka Initiative under which substantial subsidies would be given to private operators through competitive auctions for the building of high-quality broadband networks, including fiber optic links to the greater Colombo area and to the outside world for an area roughly demarcated by the towns of Weligama, Kahawatte, Bandarawela and Hambantota. The other regional network was to cover the triangle defined by Anuradhapura, Trincomalee-Muttur and Jaffna. If not for the election, these networks would be under construction right now.

But we cannot wish away the realities. While Matara and Galle contain concentrations of educated, educable youth, one has to admit that the absolute numbers of those with English skills may be somewhat less than in the Colombo and Kandy areas. This is even truer when we think of places like Buttala and Weeravila. The e Sri Lanka vision included a long-term plan to educate our young people in IT, English and “attitude.” But in the short term, it also envisaged the provision of BPO jobs that were to be generated from inside the country that did not require English. Think about calling a bank or your mobile provider about some service problem today. You will talk to someone working in a call center. Because of infrastructure problems and also a lack of imagination, these domestic call centers tend to be located in greater Colombo. But we were thinking of using the reengineering of government initiative to take the lead in moving those jobs, outsourced and managed by the private sector, out to the rural areas with adequate infrastructure. I have great hopes that this idea will continue to be pursued, especially for the South which is littered with job creation promises, but which has seen nothing concrete after President Premadasa established the garment factories.

h2. The relevance of Kornai

So far, it may appear that I have not talked of the ideas contained in the book that is being launched today. But appearances deceive. I have been building on Kornai, spelling out the implications of his recommendations on job and wealth creation in a specific context. Let me make the connections clear.

Professor Kornai talks about the need for a three-pronged comprehensive reform strategy. A key element is the recognition of, and respect for, private property rights. He does not explicitly address the infrastructure sectors, but my statements about the government creating the conditions for multiple, private suppliers of infrastructure services presupposes a private property rights regime, across the economy, reinforced where necessary by competent, independent sector-specific regulatory bodies. Respect for private property rights is not limited to not nationalizing or expropriating the property, like our government did in the 1960s. It also means keeping promises and not changing the rules in mid-stream. It includes forbearance from administrative expropriation, which is the nibbling away of the ability to earn a return from the invested capital. Regulation, which is an important aspect of modern, private supply of infrastructure services, protects investors’ private property rights against administrative expropriation, among other things.

Kornai spends a great deal of time on the necessity of getting rid of the distorted price system inherited from socialism. That is a precondition for the building of competitive infrastructure industries. All these years, government has failed to invest in the infrastructure essential for locally based firms to effectively compete in the global economy, and thereby to create wealth and jobs for our people. It must now step back and allow the private sector to provide these services. But unless the private sector is allowed to make reasonable returns by charging prices that reflect costs, they will not supply. You may have seen the burst of activity in the petrol sheds in 2003 and early 2004, when both Lanka IOC and Ceypetco started investing in their run-down sheds. But now, with the refusal of government to allow these companies to recover the extra costs they are paying in the world market for their product, the refurbishments and investments will stop. We will go back to sheds that are more closed than open; service provided by dispirited men in rags; concerns about adulteration of petrol, safety and environmental neglect and so on. Deviation from market prices leads to low investment; which leads to poor quality goods and services and shortages. This calls forth government intervention, which, absent an attack on the root cause, leads to dysfunctional regulation leading up to renationalization. Monopoly, corruption and endemic under supply reemerge. This is the vicious downward spiral initiated by administrative pricing so decried by Kornai.

But let me take one of Kornai’s most radical ideas and examine its implications for Sri Lanka in the context of service export industries in the global economy. Kornai states that prices in Hungary must be more or less the same as those in nearby countries. He even recommends that the comprehensive reform should reset Hungarian prices using the prices of commodities in Austria and Germany as benchmarks.

How can this be translated to our context? It means the drastic reduction of the prices of basic foodstuffs including rice and vegetables to match the prices in Southern India. Why Southern India? Because it is the region to which we are becoming most integrated economically, especially as the Free Trade Agreement with India takes hold; because it is our competitor in the supply of service exports; because the low food prices in Southern India enable firms located there to pay a university graduate working in a BPO a monthly salary of below 10,000 Indian rupees a month, which is approximately LKR 20,000. Can we employ a university graduate fluent in English and IT competent for LKR 20,000 a month? No. If we are to compete with Southern India in price, we have to address this problem. But can we deal with the consequences? At current agricultural prices, our farmers are drinking insecticide. If we force prices down further, what will happen? Even the market-oriented, free-trade government of 2001-04 imposed import duties on rice to artificially maintain prices at high levels. Not only that, it bragged about the tariffs during the election campaign. Who will have the courage to address the fundamental inefficiencies of our agriculture, which is protected by an intricate web of tariffs, subsidies and administrative mechanisms, but which is distorting the entire price system and making many of our industries incapable of competing in the global marketplace? If you follow the strict logic of Kornai’s argument, many of our farmers will have to find other gainful employment. We would be putting our scarce public resources to manage this transition, not to further subsidize particular varieties of fertilizer. Please note that I do not preclude the possibility that Indian prices are artificial and distorted, by things such as subsidized electricity. Given the nature of the Indian economy, what would be surprising is if they are not distorted. But that does not shield us from the challenge of getting our price signals right.

By postponing the necessary reforms and adjustments in the agriculture sector by laying subsidies upon subsidies to continue uneconomical production we will perpetuate the rural poverty trap, depriving the children of farmers of the many faceted opportunities that the urban elites give their offspring.

I want to end this talk by recalling some advice I was given by two young men from the South back in January 1999. I was at that time Director General of Telecommunications and grappling with the problem of extending telecom services to our rural areas. I had very good international advice which I wanted to balance with the input of those most directly affected, the people in the regions who were not getting the full benefits of the telecom reforms. So we assembled around 200 people each from the Southern and North Central provinces to locations in Matara and Anuradhapura respectively. The Matara consultation was held at this same hall in Nupe. I was on my feet listening, explaining, answering for hours. We got very valuable inputs that influenced many government policies and regulatory actions, including the e Sri Lanka design. But what I remember best is what two young businessmen from Kamburupitiya who had come on a motor cycle told me during a break: “Our problem is that telecom services are simply unavailable. Fix that problem and don’t bother us after that. We’ll take it from there.” I have tried to honor that request in the years since. This I think is the gist of Kornai as well: Give the people the tools and step back from paternalistic intervention; they will take responsibility for their lives and the country. I hope we will keep that in mind in the national conversation that we have initiated today.