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Sun, 19 November 2017 09:58:51
The romance of manufacturing
23 Oct, 2014 07:44:04
By Rohan Samarajiva
Every few years, someone pens a lament about Sri Lanka’s lack of manufacturing. Economic growth through services is not real, they argue. In the most recent iteration, services are equated with illegal and immoral: casinos, prostitution, drug dealing. We have to get away from services and put our shoulders to the wheel to make Sri Lanka a manufacturing power house, is the cry.

A thoughtful blogger who writes as Maathalan recently outlined the kinds of actions that the government should take. His reference point appears to be President Premadasa’s efforts to push garment factories to rural areas, not the creation of state-owned industrial white elephants by UNP and SLFP governments prior to 1977 (these he decries in comments). The current focus on infrastructure should be replaced by the creation of 33,000 (the number of villages in the country) factories, he says.

Who should create these factories? The blogger, being an intelligent and thoughtful person, leaves this vague.

There is mention of the political functionaries being able to make money from the factories to signal that he understands the realities of our political economy. But this could have multiple interpretations.

It could be that the factories will be like the rest of the government assets, owned by the government but with some rents collected by the political class. Alternatively, they could be owned by cronies.

Why decry infrastructure?

It is unfortunate that the manufacturing-services debate and the critique of infrastructure development have been conflated.

What we describe as infrastructure is what individual citizens or enterprises cannot provide for themselves in an economically efficient manner.

It makes a lot more sense for the government to build a well-designed and constructed road than for one individual or enterprise to do so. A road, by definition, is used by many. There are no economic incentives for one entity to bear the costs of a road that will be used by many, unless it is a toll road.

What happens when governments do not adequately invest in infrastructure is that individuals and enterprises devise workarounds. The government fails to deliver adequate electricity; firms invest in expensive and polluting diesel generators. The government under-provides public transport.

The result is companies running bus services for their employees (with more down time and, therefore, greater inefficiency) and individuals investing in motor bikes, three wheelers, and cars that cause congestion and pollution for all.

What good infrastructure does is that it broadens the palette of possibilities for enterprises and individuals. For example, no high-heat industries (e.g., ceramics or tiles) have been established in Sri Lanka for several decades. There is no business case because energy is expensive.

If good infrastructure policy and implementation ensures stable and inexpensive energy supplies, we are likely to see greater investment in manufacturing. One reason investments occur in services and in light manufacturing is that they are less dependent on energy inputs.

Should government promote manufacturing?

President Premadasa’s rural garment factory initiative illustrates some of the problems of the arguments made by the proponents of manufacturing. He did not try to establish 33,000 government garment factories. He was clear about who should operate garment factories in the rural areas: private firms who were already in the industry. They would be responsible for the technology, the investment, the recruitment of workers, and, most importantly, ensuring that the product had a market.

The companies had some incentives to go to the rural areas. More willing and trainable workers were available there for lower salaries. They had disincentives too: power supplies, transport to and from the port were unreliable and costlier than in the cities. What the government did was to use carrots and sticks to achieve the relocation. If the infrastructure then had been as good as it is today, the task would have been easier.

That was a different time.

Almost all apparel exports occurred under licenses that allowed them to enjoy preferential conditions from quotas. The license gave leverage to the government.

Now, government lacks such leverage. Many of the factories then established in urban and rural areas went out of business once the quota regime ended. Those that survive have adapted to the new market environment, adding greater value to their product.

Contrast this with how government-owned industries respond to changes in demand. Taxpayers are still paying the salaries of the jute factories taken over by the Bangladesh government when the markets collapsed decades ago.

Government deciding priorities?

If not apparel, what? Is the government capable of identifying what we should produce for export? Isn’t it better to leave that to the entrepreneurs?

What can the government do? Remove whatever barriers enterprises face. If taxes are a problem, offer tax holidays. If information gaps exist, help bridge them. But in many cases the most helpful thing government can do is to improve infrastructure services.

So improving ports and building highways is exactly what the government should be doing to promote manufacturing.

It appears that the biggest barrier is capital. The existence of large conglomerates (e.g., John Keells Holdings) and the emergence of new ones (e.g., Softlogic) is prima facie evidence that the capital markets are inefficient. A true entrepreneur has difficulty raising capital. Those with access to capital appear to be oriented to low-risk, quick-return activities. So both gravitate toward services. This is not something government does. But it could be an outcome of wrong government policies.

If, after all this, no manufacturing activities commence, what should the government do?

Nothing. It could act to lower the various barriers that include, but are not limited to, infrastructure and access to capital. But under no circumstances should it venture into 1970s style direct investment in, and operation of, factories.

The uncoordinated reluctance of countless decision makers who are risking their money should tell us that Sri Lanka does not have a comparative advantage in manufacturing. Their reluctance should always trump the decisions of those who are recommending the risking of other people’s money.

Rohan Samarajiva heads LirneAsia, a regional think tank. He was also a former telecoms regulator in Sri Lanka. To read previous columns go to LBOs main navigation panel and click on the 'Choices' category.

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