Getting out of a debt hole – Part 3

12 June, 2022

(Continued from last week)

12. Creating an industrial policy for Sri Lanka

The only way to change the long-term forex problem that Sri Lanka has, is to have a government-led industrial policy.

The US and the West have always argued the opposite. The conventional wisdom is that the private sector should be left to do the innovation while governments stay out of the commercial sector. The funny thing is the West did exactly the opposite when they were developing their economies. The West tells us – don’t do as we did, do as we tell you.

Prof Ha-Joon Chang’s brilliant book “Kicking Away the Ladder” is essential reading for all those interested in the subject. Prof Chang‘s primary point is that the West is kicking away the ladder that they themselves used to get to the top of the global economy.

Indeed, it works well for the West that countries such as Sri Lanka do not have a competitive advantage, and that we continue to buy Western goods and sell our tea back to the West, and that we run to the IMF and ask for debt relief when we cannot buy enough food to feed ourselves. I am not saying here that the West and the IMF are malicious – just that all of their advice and their Institutions are looking after themselves – not us. That is fine as far as it goes – but we need to be aware that that is what is happening. Let us not imagine that an IMF prescription for Sri Lanka is in Sri Lanka’s best interests. The IMF is simply doing what is best for Western institutions.

Sri Lankan, and eminent economist Prof Howard Nicholas of Erasmus University Rotterdam, has been arguing the case for Sri Lanka to have an industrial policy forever. But it seems nobody is following that advice.

I was blown away by Dr Nicholas’ comparison (minutes 3-35 in the video) of countries with and without industrialisation. Developing countries that are industrialised are the red line below with a positive current account balance while countries that are not industrialised have a negative current account (in blue) and Sri Lanka is part of that same club (green).

Prof Howard also pointed out Vietnam’s recent experience. Vietnam has turned itself into a manufacturing powerhouse. And look at what it did for Vietnam’s current account balance:

It is essential that Sri Lanka move away from its chronic forex problem to a neutral or positive current account balance and thereby to independence from foreign debt problems. The only way to do that as Dr Nicholas shows, is to industrialise.

13. Competitive advantage and industrialisation

Achieving a national competitive advantage in a sector of industry does not necessarily mean that Sri Lanka needs to focus on inherent advantages. So for example sun and sea are a natural advantage that Sri Lanka has over some other countries. But that does not mean that we must create all our industries around it.

Tea, rubber and coconut are another such advantage SL has – but again that does not mean we must build our industrialisation around that either. Singapore demonstrates that its competitiveness does not arise from an inherent natural advantage.

Let us examine two examples to demonstrate what I mean. Denmark is a world power in pig farming and pork products. Checkout this excellent article in the Economist “Bringing home the bacon”. This is a perfect template for what Sri Lanka should be doing. As you see from the article the government orchestrated a cluster of companies to create a world class pork industry. This is something even more difficult in Denmark where wages are high (GDP per capita is $61,000 PPP). You might think that the competitive advantage in pork farming would surely go to the country with the lowest agricultural labour cost. Obviously not. A sophisticated IT driven innovative industry can take on anybody in the world.

There are several key points from this for Sri Lanka:

The government must orchestrate and create the conditions for clusters of companies. (Never subsidise or directly aid individual companies. Allow each company to sink or swim. Do not prop-up failing companies. The death of a company is the rebirth of a better company).

Drive technical innovation through government support for the cluster. Relentless productivity improvement is the key to global competitiveness.

Ignore the Western religion that government should get out of the way – Western nations have succeeded by ignoring that very advice.

The second example is China’s Shenzhen. As most of you know, Shenzhen is the core of the world manufacturing industry. Shenzhen has a population of 23m – the same size as Sri Lanka, and has a GDP of $737b PPP which is a factor of 2.5 more than Sri Lanka.

Some Westerners sneer that Shenzhen’s advantage comes from low labour costs. This is far from the truth. Shenzhen consists of a massive cluster of companies from small to medium to huge that specialise in every possible aspect of manufacturing. I have personally witnessed that for myself.

As part of my business travel for my company KAL, I have travelled to China around 50 times and have been to Shenzhen numerous times. KAL has a manufacturing partner in Shenzhen. What is amazing about Shenzhen is how much expertise there is in every possible aspect of manufacturing.

For example, my industry requires what are known as encrypting pin pads (EPPs) for installation in ATMs. These are highly sophisticated electronic components that require a very high standard of security and regulatory compliance. There are very few companies in the world that can build these devices – there is one in San Jose California, one in Denmark and two in Shenzhen.

A device like that not only requires overall expertise to design the device itself but also a long supply chain for sub-assemblies and components. As you can imagine Shenzhen does it all (and I wouldn’t be surprised if some of the components required by the US and Danish companies also actually come from Shenzhen).

The point is this – this is competitive advantage that is not easy to replicate and is certainly not about low wages. It is also competitive advantage that is not built on some inherent natural advantage. It is an advantage created by a cluster of companies innovating and producing components and systems in a highly complex supply chain of parts with government encouragement where needed. Shenzhen, as you can imagine, is a cauldron of change and innovation. Companies are created and companies die. The government does not tell companies what to do. The government encourages and keeps a watchful eye. This is human capital in action.

14. How should Sri Lanka industrialise? Which industries make sense?

In many ways we can just choose, in the same way that Denmark chose pig farming. The world has massive demand for products and services. World GDP is around $100T which also means that the world buys $100T of products and services every year. We are spoilt for choice.

Let us try an idea to get the conversation going. What about the car industry? Should Sri Lanka attempt to build cars for the global economy. Err no! The car industry is dominated by huge companies like Toyota – we cannot possibly compete with Toyota starting from a position of nothing. But the car industry has a massive supply chain.

Toyota does not make every bit of a car by itself. There are thousands of components that need to be manufactured before the final car is built by Toyota. Those global supply chains are the key to Sri Lanka’s plans. We could pick a small piece of a chain – let us say the catalytic converter of the exhaust, and try to enter the world market for catalytic converters and splice ourselves into the supply chain. That’s not going to be easy though as there are existing manufacturers of catalytic convertors – so maybe catalytic convertors are not the best idea.

Obviously, it makes sense to ask what supply chains are already running through Sri Lanka and what industrial knowledge is already in Sri Lankan companies. The government should survey Sri Lanka’s industrial base and identify all companies that are already strong enough to be part of a global supply chain. The best place to start is where there is a cluster of existing companies focussed on specific links of a supply chain. Government support to those companies through R&D grants, innovation support and knowledge dissemination can help those companies to muscle-in on the supply chain and expand to adjacent links too. That is how Shenzhen did it.

15. Advice to the government on industrial policy

Identify areas that Sri Lanka can target.

Never support or invest in a single company

Always help a cluster of companies

Create independent agencies to oversee each industrial sector

Setup the agencies, write the rules, and then step back

Give them independence like the Central Bank has independence. Ensure there is no political interference. Government must never interfere in operational matters of companies, or the cluster

If the government is going to print money give it out as grants for innovation

Never subsidise individual companies or protect individual companies from failure. Better companies will arise from the death of a poor performer. If the company cannot compete in the world market it is all the better that it gives up its resources, especially the human resources, so others can do better.

16. Conclusion

This then is a blueprint for how Sri Lanka can emerge from its current forex debt woes. This is the way forward to true independence and sovereignty.

There are three things we need to do:

1.  Fix our laws to give foreigners watertight rights over Sri Lankan assets when those assets are used to secure debt

2.  Be willing to sell Sri Lankan assets when we have to

3.  Fix our long-term trade deficit with an industrial policy and do that using independent agencies to oversee clusters of local world-class companies.  


– Sunday Observer Sri Lanka

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