In The Press

-Better economic governance, not giveaways should be the focus of the new governance zone

By Resident Fellows of the Advocata Institute

Deng Xiaoping China’s great reform leader, faced a serious problem in the 1970s. Thousands of young Chinese were crossing to Hong Kong risking their lives. Rather than cracking down on the migrants, Deng sought to understand why they were migrating. Clearly the economic opportunities in Hong Kong were greater than in mainland China.

Deng was also impressed by the rapid rise of the some Asian economies, in particular the modernisation of Singapore. Singaporeans, like the residents of Hong Kong, were majority Chinese by descent and had even less natural resources. How did they achieve something that China couldn’t?

The answer was that these countries had better rules, better incentives, and better economic governance systems. Deng knew he needed to ‘reboot’ China with reforms that allowed markets to coordinate economic activity, protect private property, and allow for Foreign Direct Investment- radical reforms in communist China at the time.

He also knew that implementing these reforms in the entirety of the country would be a nonstarter. Entrenched interests who benefit from the status quo would fight to keep the existing order. To solve this, China demarcated the Shenzhen area as a special governance zone and implemented a new – more open – economic system. This was the start of the Special Economic Zones (SEZs) in China. It was promoted as a laboratory to experiment with market principles to serve “socialism”.

The results are astounding. In the past 40 years Shenzhen has been transformed from a fishing town of less than 30,000 to the third largest and rapidly growing city in China. The population of Shenzhen has grown to more than 12 million residents. In 2018, the economy of Shenzhen was $ 366 billion, four times that of Sri Lanka. Many more SEZs now exist in China and around the world.

Sri Lanka’s problem

In some ways, Deng’s problem is now Sri Lanka’s problem. To be sure, emigration out of Sri Lanka is not as severe as it was in 1970s China. Sri Lanka’s business environment is also not as bad as the Chinese system at that time. Yet market based reforms started in 1977 have all but stalled.

Like China, in “mainland Sri Lanka” too an entrenched elite who benefit from the existing system lobby to maintain the status quo. The result is that very little progress has been made over the last 15 years on reforms necessary to boost economic growth. After a brief post-war spurt between 2010-2012, economic growth slumped and has remained stagnant.

This is visible in Sri Lanka’s low scores on various rankings that measure the efficiency of the business environment. In the World Bank’s influential Ease of Doing Business report, Sri Lanka is ranked 99 out of 190 jurisdictions. The country has fallen behind countries like India, Bhutan and Nepal, having once been an early economic reformer in the region.

Governance system

Take the legal system, where Sri Lanka is one of the worst performers in the world. In contract enforcement, the World Bank ranks Sri Lanka 164 out of 190, taking on average nearly four years to enforce a contract. In Singapore, it takes just over five months. It’s no wonder that foreign investors prefer easier destinations to deploy their capital. Delayed enforcement is lost money.

This should be the logic for the Colombo Port City. Poor governance is a barrier to growth in many developing countries but implementing broad reform for better governance is extremely difficult. The idea is that by building special governance zones, governments could adopt completely new systems that overcome the problems that exist in the rest of the country. These zones would operate like “one stop shops” with pre-approvals and fast-tracked court systems, making doing business easier and hopefully attract foreign investment.

Special zones are not new in Sri Lanka. Much of Sri Lanka’s export industry resides in the country’s dozen or so Free Trade Zones. Colombo Port City is different by virtue of being the first special zone managed by an international operator. Unlike the FTZs, the focus is on white collar jobs and financial services instead of manufacturing exports.

It also has a broader remit- the proposed legal structure lists seven laws that don’t apply to Port City, and a further 14 that could be exempted in the area by the proposed oversight body. The Port City masterplan promises world class living facilities, entertainment, financial services, and business.

Yet Port City’s success, and indeed its importance to the country, will only depend on its ability to provide a superior governance system. To be a success Port City will need to guarantee greater economic freedoms to its investors, have an efficient legal system with clear and predictable laws, and decisions based on precedent. It needs to minimise discretion of the commissioners and have a fair and transparent regulatory structure. These are the critical features that have made several small cities like Hong Kong and Singapore prosper. Basically, rule of law should apply and prevail.

This is the Port City we need. A better governance zone that can attract FDI, skilled people, spread knowhow, and serve as a lab for policy experiments. Get this right, and Port City could create positive spillover effects for the rest of the country in terms of economic opportunity and hopefully scale some of the more open policies in the enclave.

What of the Port City we will get? In the coming weeks, the country will debate whether the specific provisions in the Port Bill are prudent. The Supreme Court is already hearing 19 petitions that challenge its constitutionality. Like any project of this nature, there are also political and economic risks that need to be considered.

Managing the geopolitical risk is going to be an enduring challenge in Sri Lanka. Here there are no easy answers, except professional management of our foreign affairs and dealings. Big picture thinking is needed instead of the current win/lose mindset and transactional diplomacy.

Economic distortions

Another risk is in the domain of economic distortions. Unlike in Shenzhen which was conveniently located far from the commercial centres at the time, Port City is on the doorstep of Sri Lanka’s capital. After the operation of the Port City, life as a businessperson could be very different depending on which side of the Chaithya Road your business is situated. You may be competing for the same resources but face very different rules and taxes. The latter is a deeper malaise.Already stretched for revenue to cover even its debt obligations, the Port City may prove to be a leakage point of taxes for the State. Finally, given its proximity to Colombo, there is a risk of capture of the regulatory framework of the same elite who have secured rents for themselves in the existing system. It’s no accident that successful SEZs tend to be away from the established power centres, such as Shenzhen was to Beijing.

Only good rules, predictable policies, and oversight can overcome these challenges. A focus on better governance rather than tax breaks and giveaways would help keep the house in order.

It would obviously be better for the entire country to be governed by better rules and efficient systems that enhance ease of doing business. Given its size and scope, the Port City cannot perform miracles, but we can hope that Port City would be a catalyst in bringing about some of these changes to the country proper.

The project itself is an admission of failure in governance. Even when Sri Lankan leaders know what to do, a combination of backward ideology, political opportunism, vested interests, and lack of State capacity seem to hold back the vital growth oriented reforms. It is these reforms that are needed to expand economic opportunities for all Sri Lankans.

The Port City can give the country a shortcut to attract foreign investments, provided it focuses on the right thing – better economic governance.