By Ashani Abayasekara (Research Assistant)
and Anushka Wijesinha (Research Economist) – IPS
Economic freedom measures have ranked Sri Lanka above its neighbours in the region, but below some of its key competitor countries. To improve the business environment by addressing problems such as transparency, accountability, etc., there needs to be a genuine effort to involve all stakeholders…
The concept of economic freedom is not a novel one in economic theory. Since the time of Adam Smith, if not before, economists have believed that the freedom to choose and supply resources, compete in business, trade with others, and secure property rights are central ingredients of economic progress(1). With the recent global financial crisis being primarily attributed to perverse credit expansion and regulatory policies in the financial sector, the concept of economic freedom has attracted renewed attention worldwide. How easy or difficult it is to start and run a business, and how efficient courts and insolvency proceedings are, can influence how firms cope with crises and how quickly they can seize new opportunities(2). While Sri Lanka ranks relatively well in economic freedom in the South Asian region, its position worldwide remains much to be desired, mainly owing to problems of good governance, increasing non-tariff barriers and the heavy presence of the state in the economy. Reforming regulations and creating a conducive climate for economic activity is thus crucial. This task however is not solely the responsibility of the government – there remains a significant role for other stakeholders of the business environment to play as they are all part of the ‘business ecosystem’.
Economic Freedom: Link to Growth and Development
As pointed out by Madan (2002), economic freedom is important as it has been linked to economic growth and can be a basis for determining why some countries perform better than others. Several empirical studies establish a positive correlation between economic freedom and economic growth(3). Going beyond economic growth, an empirical study by Dehann et al (2006) demonstrates some positive relationships between economic freedom and indicators of well-being; income per capita, income level of the poorest 10%, life expectancy, and life satisfaction(4). Many of the relationships, however, reflect the impact of economic freedom as it works through increasing economic growth, and therefore do not necessarily show a direct causal relationship between economic freedom and these variables.
Economic Freedom Measures: How Does Sri Lanka Perform?
Over the last two decades, a number of indicators for economic freedom have been developed. Apart from the frequently cited Doing Business report published by the World Bank and the Global Competitiveness Index (GCI) constructed by the World Economic Forum, several other indices look at economic freedom in particular, such as the Economic Freedom of the World index (EFW) (Fraser Institute) and the Index of Economic Freedom (IEF) (Wall Street Journal and Heritage Foundation). According to the EFW, in 2010 Sri Lanka ranks 101 out of 141 economies with an overall score of 5.89 out of 10. Meanwhile, the IEF in 2011 places Sri Lanka 107 out of 183 countries with a score of 57.1 out of 100. The number of indices and the wide-ranging areas covered by each give an indication of the extensive nature of the concept of economic freedom. In fact, there is still no unique way of defining economic freedom. This article primarily focuses on the degree of economic freedom present in the business environment in Sri Lanka; looking at the extent to which regulations and bureaucratic procedures constrain business activity, makes entry and exit problematic, and reduces competition and vibrancy in product and related markets.
The overall IEF score places Sri Lanka above its regional average, but below the world average and significantly below “free economies” (Fig. 1). However, it does not entirely make sense to benchmark Sri Lanka against the world average – this score does not suggest much, given that it gets averaged out across ‘highly free economies’ to economies with little or no economic freedom. Instead, it is important to benchmark ourselves against a basket of competitor countries which compete with Sri Lanka in attracting investments. Fig. 2 shows the overall economic freedom score and scores for components on business, investment and labour freedom for Sri Lanka and some developing country competitors (India, Bangladesh, Vietnam, Indonesia, and Mauritius). While the overall score for Sri Lanka is on par with the other selected economies, its investment and labour freedom scores are lagging behind. However, according to the fifth major area of the EFW index (Fig. 3) – ‘Regulation of Credit, Labour and Business’ – Sri Lanka ranks well in terms of labour market regulations but lags behind the developing country average in credit and business market freedom.
Economic Freedom Measures: Take With a Pinch of Salt?
The use of such economic freedom measures in comparisons across countries is questionable, given various concerns regarding their reliability. On the theoretical side, in the final analysis many indices are not very sensitive to substantial variations in the weights of different components. Comparisons are also marred by differences in collecting statistical data across countries, on which these indices are based. The data collection processes itself have come under severe criticism – anecdotal evidence in the past suggests instances where surveys are conducted at the departure lounge of airports, with interviews being carried out fleetingly with one consultancy firm. Thus, the figures are not completely reflective of the reality. This in fact can be observed in Sri Lanka’s ranking in terms of labour market freedom. The EFW index depicts Sri Lanka as doing well, above both the regional and developing country averages. However, this is hard to explain, given rigid labour market regulations in the country. Sri Lanka’s Termination of Employment of Workmen Act (TEWA) requires that firms with 15 or more employees must justify layoffs and provide generous benefits to displaced workers. The redundancy costs in terms of number of weeks of salary that is required to be paid in Sri Lanka is a staggering 217, compared to 56 and 87 in India and Vietnam respectively(5).
Nevertheless, it is imprudent to fully dismiss such measures purely on this basis – it is clear that there are economic reforms that are crucially required to some extent, if not to the same degree as reported. However much these indices are criticized domestically, on various grounds, they are a key element in the basket of factors that foreign investors and business partners look at when considering doing business with/in Sri Lanka.
In this context, reforming business regulations and creating a good economic climate is not exclusively the responsibility of the government. The relationship between the government and other stakeholders of the business environment is inextricable. The role of stakeholder groups including shareholders, employees, employers, customers & suppliers, competitors, Trade Unions, consumer groups, and the media is critical as they affect the activities of a business, and are in turn affected by its business environment.
Improving Business Regulations: Stakeholder Involvement is Key
Most enterprises seem to believe that the relationship between stakeholders of the business environment and the firm is one of the key elements of corporate success, if not the most critical factor. The role of various stakeholders may be even greater in many Asian businesses, where a key challenge is to prevent the abuse of power by controlling authorities. Many indices reveal wide-spread corruption in South Asian economies, and Sri Lanka is no exception. The dissemination of information and channeling of feedback about policy and regulation among relevant business players, specifically small and medium enterprises (SMEs), and providing a potentially supportive community for the successful implementation of policy and regulation is important. Another key initiative is the implementing of industry standards or resolving industry conflicts internally, thereby strengthening the private sector without need for government intervention.
Furthermore, regulatory and supervisory agencies, civil activists, the media, and consumer groups can play an important role in enhancing business governance. For example, securities regulatory bodies and fair trade commissions are directly involved in setting and enforcing the rules on the conduct of business for the purpose of protecting investors. Media attention can motivate politicians, bureaucrats and managers, who are concerned about damage to their reputations, to adopt more effective corporate governance laws, policies, and practices. Consumers, by bringing to light issues relating to product quality, service delivery, negotiation processes, etc., can make a significant contribution towards enhancing the overall business environment.
In Sri Lanka, there is a need for all stakeholders (in particular, the private sector) to find strategic ways of actively engaging themselves along with the public sector in policy reform processes, rather than merely voicing their concerns. In this regard, an important initiative taken is the ‘Private-Public Dialogue’ (PPD) mechanism run by The Asia Foundation in 5 Provinces. It appears to be an effective model where both the private and public sectors work collaboratively with local stakeholders to address local-level business regulatory issues. An important characteristic of the PPDs is the aim to promote transparency and economic governance by disseminating information and creating conditions for improved business vibrancy in each locality.
Improving Business Regulations: When Stakeholder Involvement is Weak…
In Sri Lanka, the problems of transparency and inclusive policy-making are reflected in the ‘Transparency of Government Policymaking’ component under the World Economic Forum’s Global Competitiveness Index (GCI), where the country ranks 107th (out of 139 countries) in 2010-2011, compared to India, Vietnam, and Bangladesh which rank better at 42nd, 73rd, and 106th respectively.
The lack of transparency and stakeholder consultations in implementing laws was evident in the Employees’ Pension Benefits Fund Bill (EPBFB), a proposed pension scheme for private sector workers which was to be passed in Parliament, but had to be postponed due to opposition from Trade Unions and employers. The opposition was mainly due to several uncertainties regarding the Bill, such as whether it was optional or compulsory, what the payment formula would be, and doubts associated with eligibility for pension at old age given the various conditions in the scheme’s implementation. The National Labour Advisory Council (NLAC) is the de facto consultative body for labour legislation and labour issues, and could have been tasked with leading stakeholder consultations on this proposed scheme on behalf of the government. However, it was not adequately consulted or utilized. It is now clear that the Bill was rushed, and did not go through a robust and inclusive consultative process, resulting in far too much opposition, dissention, confusion, and antagonism. This was unfortunate especially because most of the stakeholders, in principle, do not oppose the concept of this scheme and the need for it; just the procedure in developing it, and also key features of it.
Businesses, Yes, But Consumers – Underrepresented in Sri Lanka
An important, yet often neglected group of stakeholders – consumers – have remained under-represented due to lack of influential lobbying power. While producer interests are represented through chambers of commerce and other organizations, strong consumer associations are lacking in the country. In an era of globalization and liberalization where market forces are strong, consumers need to be protected from vulnerabilities arising from hidden strategies and processes implemented by producers and sellers. CUTS International (Consumer Unity and Trust Society), a consumer association founded in 1983 in Rajasthan, India, has been instrumental in providing a forum for disadvantaged consumers by focusing on issues of consumer protection, safety, and rights. There is a need for such organizations to be established in the country with the aim of creating consumer awareness, skills training, etc., so as to productively and proactively involve consumer groups in creating a better business environment.
Improving Business Regulations: Policy Challenge
In striving towards achieving a higher degree of economic freedom, the need to ensure that the inputs and participation of all stakeholders, including politicians, officials, the formal and informal private sector, and civil society, are reflected in the reform process is crucial. A major problem in the private sector is the tendency to go in line with every political regime so as to minimize “political risks”. In this context, a challenge is to get to strategic solutions that will create the right incentives for the private sector to push for sustainable and inclusive growth. Encouraging more direct participation of SMEs in higher level dialogue in PPDs is important, considering the need for a more mass-based bottom-up push for reform and change. There is also a pressing need to incorporate the principles of good governance – transparency, accountability and legitimacy – as an integral part of the policy process. Finally, a key challenge is to shape stakeholder/interest group dynamics so as to achieve the best possible (‘satisficing’, rather than optimizing) solution in terms of winners and losers.
1 North, D. and R.P. Thomas (1973), “The rise of the western world: a new economic history”, Cambridge Press,
2World Bank (2011), “Doing Business 2011: making a difference for entrepreneurs.” [http://www.doingbusiness.org/reports/global-reports/doing-business-2011]
3 Barro (1996), DeHaan and Sturm (2000), DeHaan and Siermann (1998)
4Fraser Institute (2011), “Economic Freedom of the World: 2010 Annual Report” [http://www.freetheworld.com/release.html]
5World Bank (2011), “Doing Business 2011 in South Asia: Making a Difference for Entrepreneurs.” [http://www.doingbusiness.org/reports/global-reports/doing-business-2011]