Role of the State in Socio-Economic Development: Some Issues to Consider for Sri Lanka

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by Malathy Knight (Research Fellow) & Anushka Wijesinha (Research Officer) – IPS
 ‘The Economist’ of March 19th 2011 carried an article titled “Taming Leviathan: A Special Report on the Future of the State” (http://www.economist.com/node/18359896). We draw on selected policy issues highlighted in that article, in the specific context of the state and socio-economic development challenges in Sri Lanka. This piece flags crucial public policy concerns surrounding the evolving role of the state, with the aim to stimulate an informed debate, and help begin to identify strategic solutions to bridge the gap between ‘policy rhetoric’ and ‘implementation’. The issues highlighted do not place onus on a particular regime in Sri Lanka, past or present; rather, they are relevant to the practice of governance of successive regimes over the years.
 
Moving from ‘Leviathan’ to ‘Embedded Autonomy’

The term “Leviathan” originates from a piece on the structure of society and governance written in 1651 by Thomas Hobbes, one of history’s well-known commentators of political thought, where he prescribes a strong state and centralized decision-making whilst rejecting the notion of ‘separation of powers’. Since Hobbes prescription centuries ago, political thinking has evolved dramatically. The division of powers is now a fundamental principle of governance in most modern day states, including Sri Lanka. Moreover, the trajectory of development shows that the pattern of centralized state-led decision-making is not ubiquitous.  Ebbs and flows in the state’s role in economic development are reflected in the cyclical waves of nationalization and privatization evidenced in countries throughout the world, including Sri Lanka.

At a more fundamental level, international and domestic policy experience demonstrates the futility of expecting a full dichotomization of states and markets. As described in what the eminent sociologist and political scientist Peter Evans terms ‘Embedded Autonomy’ in a book on states and industrial transformation published in 1995, the state and society are ‘inextricably bound’. This thinking is also reflected in the writings of renowned scholars such as Robert Wade, Ha-Joon Chang and Charles Wolf Jr., to cite a few. What this means in the context of reforms is that the nature of state-society connectedness and meshed networks influence policy inputs, the dynamics of the policy-making process and policy outcomes; and, that government failures are as real and can be as disruptive as market failures.  Similarly, “labels” such as welfare state (Bismarck), developmental state (Chalmers Johnson), regulatory state (Giandomenico Majone), post-bureaucratic state (Tony Blair), etc., must be seen in their broader context. Most often, all these incarnations of the state co-exist in the same jurisdiction at the same point in time. Pigeonholing the state into one dimension eschews a holistic understanding of the socio-economic and political institutions that shape the development process. What would be more useful in terms of inclusive and sustainable development is to view the policy process as an outcome of strategic and dynamic interactions amongst several key stakeholders/interest groups, whether in the public or private sphere. Moving the loci of decision-making from the state to broader socio-economic and political networks – what the public policy literature terms ‘the policy space’ and what Peter Evans terms ‘embedded autonomy’ – is crucial for participatory development.

A First Look at the Issues to Consider

What is apparent is that Sri Lanka has a unique opportunity to ride the wave of optimism, seize the moment and make the vision – ‘Sri Lanka: The Emerging Wonder of Asia’ – happen.

Any change creates winners and losers. As evidenced in the examples from countries ranging from the United States and the United Kingdom to China, Singapore and Brazil set out in the piece from ‘The Economist’ – reforms inherently pose challenges. Policy makers are forced to make political economy trade-offs and strategic choices in a world where first-best solutions are hard to come by and are often politically tricky. Perceptions matter in public policy. This brings us back to the crux of this blog article: what is required of the state in post-war Sri Lanka; what does reshaping the state mean in the context of the socio-economic development imperatives in the country; and, what are the crucial public policy concerns that need to be addressed to seize the moment and bridge the gap between policy rhetoric and reality?

To this end, there are several relevant categories of issues to consider, some of which are beyond the scope of this blog article. We present a few key points for consideration in the context of participatory development in post-war Sri Lanka: 
•    What “model” of socio-economic development is Sri Lanka following in the aftermath of the war? To what extent is this development approach a reflection of global trends/policy transfer? How have domestic political economy factors influenced the policy process and policy outcomes? Can the “Sri Lankan model” of socio-economic development achieve the vision of putting Sri Lanka on a rapid yet sustainable and equitable growth path?

•    What are the regulatory governance priorities that policy makers need to be cognizant of in order to achieve the socio-economic growth targets set out in the government’s vision statement? What are the major roadblocks in getting to a regulatory governance framework that would facilitate inclusive and sustainable development?

•    Is participatory development in Sri Lanka linked to participatory/collective decision-making? Are policy decisions a function of broad-based stakeholder consensus; or do narrow interest group dynamics shape policy outcomes?
 
Learning from ‘Bamboo Capitalism’?  

China is of particular relevance to Sri Lanka for more reasons than one. The two nations have had close diplomatic ties for over five decades. Changes in the politics of international aid have positioned China as one of Sri Lanka’s largest donors in recent years. The Chinese “model” of development seems to have some influence on the current development strategy. 

The ‘Beijing Consensus’ (BC), recently conceptualized, is widely perceived as an alternative approach to the ‘Washington Consensus’ that dominated public policy debate and practice in the late ‘80s and ‘90s. In a nutshell, the BC stems from an effort to unpack the story behind China’s double-digit growth figures and its nearing the status as the second-largest economy in the world, while having a strong-state role in this feat. Proponents of the BC argue that China’s success points to the wonders of state-directed capitalism; that the numbers have been conjured by the heavy and visible hand of the state. Aside from the political palatability of this argument, it appears to be way off the mark in providing a convincing explanation for China’s stellar performance. As set out in ‘The Economist’ of March 12th, 2011, the remarkable feature about Chinese capitalism – what it terms ‘Bamboo capitalism’– is the ‘blurring of lines’ between the public and private sectors in the development process. This is a veritable example of ‘embedded autonomy’ – the loci of economic activity moving seamlessly between the state and the market, with and state-societal links shaping development outcomes. 

The Government of Sri Lanka’s (GoSL’s) vision for growth explicitly shuns privatization as a policy option. Rather than ownership change, management reforms within state-owned enterprises (SOEs) and public-private partnerships (PPPs) – particularly in the case of infrastructure development – are what are touted as the alternative.

Regional disparities in economic and social opportunities for growth, access to basic infrastructure services, and access to markets became more apparent in the aftermath of the war. The pressing need to address lop-sided growth is clearly set out in the GoSL’s policy vision; and, the state’s role in facilitating and creating an enabling environment for private investment and entrepreneurship is given significant emphasis.
There is a notable gap however, between this policy vision and ground realities. Management reforms, as evidenced in past attempts to introduce Performance Contracting in the SOEs, pose significant political challenges when the notion of a patriarchal state has been embedded in the perceptions of stakeholders over several decades. Even as at 2010, the Central Bank estimated expenditure on salaries and wages for public servants at 5.4% of GDP; and, the business media and opinion polls continue to highlight public debates on Sri Lanka’s expanding state apparatus. The fallout of a bloated bureaucracy that is opposed to change is seen in the enormous loss-making SOEs – the Ceylon Electricity Board, Ceylon Petroleum Corporation, Sri Lanka Central Transport Board and Sri Lanka Railway. Perceptions of a “big state” have been further buttressed in recent years with the nationalization of major entities such as Shell Gas, Sri Lanka Insurance, and Apollo Hospitals.

 
Some key issues for discussion that emerge from these ground realities are:

•    Questions are being asked whether the Sri Lankan state is over-extending its potential by venturing into ‘business’. Does this amount to inefficient crowding out of the private sector or efficient crowding in of the private sector? Should the state focus its energies only on rebuilding social capital where the return on private investment may well be low? Does the comparative advantage of the state lie in growing business or in facilitating business? What are the concrete policy measures that the state needs to adopt to facilitate business, particularly in areas under-served during the war?

•    The vision for development set out by the GoSL envisages a rapid increase of private investment in the country, both domestically and through foreign direct investment (FDI). The past decade saw average inflows that amounted to just 1.5% of GDP, and the target for the next decade is to double the level of inflows in key sectors such as tourism, IT/BPO services, renewable energy, etc. The Board of Investment (BOI) is in the process of being revamped to facilitate increased FDI flows. Post-war optimism affords a significant window of opportunity to draw in investment. As highlighted earlier, policy changes in terms of state ownership of previously privatised entities have sent out mixed signals to the business community and impacted investor perceptions. There have been recent statements in the media by the Secretary of the Ministry of State Resources and Enterprise Development on the government’s initiatives to rationalize and commercialize loss-making SOEs with a determined focus on attracting private participation, which are certainly movements in the right direction. So, how can the uncertainties be bridged and the right incentives be created to encourage the private sector to take up these opportunities?

•    The need for rapid roll-out of infrastructure in the aftermath of the war is set out as a key policy priority of the government and PPPs are seen as crucial modalities in the infrastructure drive. However, as reflected in the latest figures released by the Central Bank, state investment in infrastructure development stands at 6% of GDP as at 2010, with investment in social infrastructure such as health and education accounting for only 1% of the total. Clearly the state still maintains a heavy presence in the development of physical infrastructure in spite of the policy vision to encourage Private Public Partnerships (PPPs). What do policy makers need to do to crowd in private investment; to create a conducive business environment for PPPs? Do PPP stakeholders in country truly understand what constitutes a PPP? What governance and regulatory structures need to be in place for the before, during, and after a PPP project to ensure credibility and a secure win-win for the state and private players? Do key government offices handling PPPs have the requisite capacity and expertise for administering a PPP drive? Are we looking sufficiently at international best-practices for PPPs?

Reforming the state is not an easy task in any jurisdiction, given the political economy realities inherent in any country. In that context, there needs to be a critical discussion on the feasible options for change, and ensuring credible policy continuity.
 
Good Regulation, avoiding Strangulation

The preceding discussion highlights the crucial role of the state as a facilitator and creator of an enabling environment for investment, business and entrepreneurship. Regulating that environment and its players are equally important, while always striking a healthy balance so as to ‘police’ effectively while not snuffing out private initiative. Sound regulatory institutions are vital for positive development outcomes. Regulatory risk poses a big threat to investment and regulatory risk is shaped by perceptions – perceptions of policy consistency, credibility, and the business climate. International best practice shows that good regulation should have as its core guiding principles:

–    Regulator to practice regulation for competition and contestability rather than regulation of competition

–    Regulator to have ‘workable independence’ – i.e., operational and financial independence to ward off political and regulatory capture, as ‘complete independence’ is a superfluous idea.

–    Regulator to be accountable and transparent

Let’s take a brief look at a sample of episodes/events that have dominated public discussion of regulatory governance in Sri Lanka in recent years, in an attempt to get to a better understanding of the status quo.
      Construction costs associated with the Colombo-Katunayake expressway have almost quadrupled from approximately Rs. 9 billion in 2000 to Rs. 32 billion at the time of writing. These numbers include damages paid to the South Korean company originally contracted to build the highway and the costs associated with the renegotiation of the project contract with a new Chinese company. The numbers do not capture negative externalities linked to signals sent out to potential investors and the impact on future investments.
    A press release by Fitch Ratings Lanka last month, stated that Sri Lanka has the highest ‘telecom regulatory risk score’ in the South and South-East Asian region. The rating agency cited a low level of transparency in regulatory decisions and abrupt policy changes as being crucial factors influencing risk perceptions in the telecom sector.

    The Central Bank of Sri Lanka Annual Report 2010 provides the latest figures for Sri Lanka’s ‘Doing Business Ranking’, as set out in the World Bank publication ‘Doing Business 2011: Making a Difference for Entrepreneurs”. In spite of the various methodological limitations attached to aggregated cross-country rankings such as the ‘Doing Business’ survey and Transparency International’s ‘Corruption Perception Indices’ (CPI), these scores do impact on stakeholder perceptions. Whilst the latest CPI score for Sri Lanka indicates a marginal improvement (http://www.tisrilanka.org/?p=6386), the Central Bank states the following with respect to the country’s ‘Doing Business Ranking’:”..performance in the stages of Dealing with Construction Permits, Registering Property, Paying of Taxes and Enforcing Contracts is particularly weak as it ranks below 100 of the 183 countries considered and therefore, pulls down the country’s overall ranking. In fact, in the areas of Dealing with Construction Permits and Registering Property, it fares worse than the worst performing country, Chad. Out of the economies considered, Sri Lanka’s performance falls below 10, namely Singapore, Hong Kong, South Korea, Thailand, Malaysia, Mongolia, Vietnam, China and even the South Asian countries like Pakistan and Maldives. As some of Sri Lanka’s competitors in trade are included in this group, it is a matter of concern that Sri Lanka performs worse than them.” (CBSL Annual Report, pp. 24-25)

    The Public Utilities Commission of Sri Lanka (PUCSL), established under the PUSCL Act of 2002, stands out as an example of best practice regulation. The PUCSL is accountable to Parliament- in direct contrast to sector regulators in telecom (TRC) and transport (NTC) that report to a single Ministry. What are its superior elements? Appointments to the Commission are made by the Constitutional Council (CC) set up under the 17th Amendment to the Constitution. Issues of regulatory capacity deficit and overlapping jurisdiction are addressed in the multi-sector structure of the Commission. Language relating to Regulatory Impact Assessment (RIA) is built into the Act. Yet, while its structure is in place, effective operations are hamstrung by political economy factors beyond its control. Political gridlock surrounding the 17th Amendment has impeded its functioning.
This narrative of regulatory governance in Sri Lanka points to the following key discussion issues:

•    What strategies need to be adopted to make policy makers accountable for their decisions and actions? What can we learn from India’s 2G spectrum scandal that forced the resignation of the Minister of Telecom?
•    Are wage increases a possible solution to the problem of rent-seeking/graft? The quality of Singapore’s civil service for instance, is a result of keeping the state lean and mean, with public sector salaries being on par with those in the private sector. Is the Singapore “model” one we can adopt? What strategies are required to deal with over-employment in most state entities in the absence of sound safety nets? What needs to give on the fiscal front to recruit highly skilled technocrats into the public sector?
•    Are RIA and sunset clauses feasible options for regulatory reform?
      
Better Policy Engagement for Inclusive Policy-making

Development policy that is not founded on participatory decision-making rebuts visions of inclusive growth. Public discussions on the lack of what Mancur Olsen terms as ‘voice’ in his seminal piece ‘The Logic of Collective Action’ (1965) – what, in common parlance, means an active civil society – point to the three-decade North-East conflict as the main reason for general apathy on the part of the polity. However, the war is now over. Good governance includes bottom-up checks and balances, as well as inclusive policy-making.
A good example of the lack of the latter, was the uproar caused by the proposed Employee Pension Benefit Scheme being introduced, through a process which both employer and employee groups called ‘unprecedented’. Intense discussions with relevant bodies like the consultative National Labour Advisory Council (which is cross-representative of labour market stakeholders) as well as the Employers Federation of Ceylon (EFC), and numerous worker’s groups, was severely lacking until the last minute. This left too many questions unanswered, too much room for speculation and opposition, and eventually led to severe tensions between the government and trade unions, including street protests. The heavy opposition could have been avoided with a genuine engagement and robust consultative process during all stages of the policy-making process. Yet the debate and dissent surrounding this issue aptly demonstrated that the citizenry will not always remain tolerant of imposed policies, and would no doubt be a lesson for any government.

More generally, however, catering to the vote base and to electoral cycles is rational political behaviour, no doubt. ‘Pork-barrel’ politics all over the world hinges on patronage and powerful interest groups. Sri Lanka is no exception to this as evidenced in the dynamics of public policy spanning successive political regimes over decades.
Yet, whilst collective decision-making remains a laudable objective, it is also one of the stickiest challenges in governance. However, changes are possible as India can show us. The ‘e-Panchayats’ being held across India, even in the remotest of villages, demonstrate how technological advances are changing the possibilities for better governance. India’s ‘Right to Information Act’ is transforming the ability of ordinary citizens to hold their politicians accountable, and in turn is slowly changing the ability of politicians to misuse the citizens’ mandate. However, access to information and the ability to act on that information pose entirely different challenges. Going bottom-up is a slow and difficult process. Discussing how to get there would perhaps be a good starting point.  This article aimed to be that starting point, by providing a backdrop for an informed, objective, and constructive discussion on the role of the state in Sri Lanka’s new era of development.