DOES HISTORY OFFER A CLUE TO THE DIRECTION OF FUTURE REFORM?

Eighty years ago, Sri Lanka’s first state businesses were established to deal with supply shortages arising from the second world war

The reform of State enterprises (SOE’s) has been much discussed, with good reason. They play an outsize role in the economy; therefore, their inefficiencies will drag overall growth. What’s not often considered is their history and how the state started getting into business? And why? Examining this may bring some perspective to the need and direction of future reform.

ORIGINS AND EXPANSION

The emergence of state enterprises in Sri Lanka was due to the exigencies of the Second World War, which disrupted trade links and created scarcities in the domestic market. Factories were set up for the manufacture of coir (1940), boots and shoes (1941), steel re-rolling (1941), plywood (1941), paper (1942), acetic acid (1942), quinine and drugs (1943), glass (1944) and ceramics (1944).

The government was compelled to guarantee the regular supply of essential needs for the war effort. Acetic acid was required for the manufacture of rubber, plywood for tea chests and leather for boots and hats of soldiers. The government wanted the private sector to take up these ventures, but despite offers of financial and technical assistance, none were willing. The problem we now understand as one of know-how: these were new ventures and lacking any knowledge in the area, no one was willing to take the risk. The war meant that investment from overseas – a common route for knowledge and technology transfer was closed. The Government stepped in to fill the gap. The war brought about the general acceptance of Keynesian policies. Between 1945-70 both the right and left in the UK supported these policies. At the end of the war, the colonial government in Sri Lanka appeared to be in favour of an expanded public sector. Two state State Council committees advocated this in 1946 and 1947.

The leaders of the UNP government that came into power in 1947 were drawn from landowners who were sympathetic to agriculture. This attitude, together with the scarcity of foodstuffs post-war lead the government to prioritise agriculture over industrial development. A government commission and an IBRD (International Bank for Reconstruction and Development, a forerunner to the World Bank) commission recommended that there be no state management in industrial undertakings and proposed gradual disengagement. The Government Sponsored Corporations Act No.19 of 1955 was enacted to provide the legal framework for the transfer of government undertakings to the private sector.

The change of government in 1956 brought about change in attitude. The SLFP’s 1951 manifesto declared that all essential services including large plantations and transport, banking and insurance, should be progressively nationalised. Thus State-Owned Enterprises (SOEs) re-entered the Sri Lankan economy mainly in 1956 when the government of S W R D Bandaranaike made a conscious effort towards industrialisation. Following the then dominant thinking in development ideology, successive governments followed a policy of import substituting industrialisation via import controls and direct state involvement in production, trade and finance. These policies were followed up by the nationalisation of large private companies in the late-1950s; bus companies, insurance and foreign-owned companies.

This proliferation of state enterprises continued into the early 1960s and 1970s (especially during the Sri Lanka Freedom Party (SLFP) led governments of 1960-65 and 1970- 77). The 1960s saw the setting up of the Ceylon Petroleum Corporation (CPC) and Ceylon Electricity Board (CEB). The People’s Bank was established in 1961 and expanded rapidly. Plantations were nationalised in 1975 under the 1972 Land Reform Act, while the Business Acquisition Act of 1971 accelerated the nationalisation of private sector businesses.

All this meant a rapid expansion of the public sector. Between 1970 and 1977, the public sector increased from 21% of Gross National Product (GNP) to 24% of GNP, while its employment grew from 135,019 to 617,033. Accompanying this was an increase in corruption and political patronage, especially in grating jobs in the state sector. These policies gained political and social support by supporting non-financial and populist objectives; redistributive justice, regional development (paper factories in Valachchenai and Embilipitiya), price regulation of essential products (Cooperative Wholesale Establishment retailing food items below market price), providing employment and training. To achieve these objectives and to ensure their viability, these SOEs became virtual state monopolies in their respective sectors.

POST-1977 LIBERALISATION, REFORM AND PRIVATISATION

Despite the open economic policies implemented under the 1977 UNP government, no significant change took place in the state’s direct involvement in production, trade and finance via SOEs. Liberalisation was confined to deregulation and reducing controls.

However, some trading monopolies were broken up, a venture in flour milling was arranged, foreign banks were permitted to operate, and bus transport was open to the private sector. With hindsight these were not particularly successful. Flour milling ended up replacing a public monopoly with a private one and lacking any commitment to service, private bus services deteriorated.

The SOE’s seemed to enjoy broad public support and increasing political violence put any putative reform on the backburner. There was no immediate pressure for change either as concessionary foreign aid provided the government with the breathing space necessary to sustain the SOEs.

However, the reduction in import duties that accompanied the open economic policies meant that SOEs found it challenging to compete with imported goods amidst declining productivity and efficiency. As a result, they needed tariff protection and state subsidies, going against government policy and burdening the budget.

Privatisation only became a state policy in 1987 which lead to the “Conversion of Government-Owned Business Unites (GOBUs) into Public Corporations Act, No. 22 of 1987” and “Conversion of Public Corporations of GOBUs into Public Companies Act, No. 23 of 1987”, which created the legal framework for privatisation.

The development of the Colombo Stock Exchange (CSE), the establishment of venture capital and unit trust funds enabled a participatory process of privatisation with 10% of shares in ventures being distributed free among employees based on length of service in the SOE. This allowed employees to benefit. However, by 1991, budgetary support for the two plantation corporations – Janatha Estate Development Board (JEDB) and State Plantation Corporation (SPC) – amounted to Rs1.68 billion and was no longer sustainable. Poor productivity and reduced profitability lead to increased indebtedness to the state banks and the Treasury. This prompted further reform which transferred management of a majority of the estates under these two corporations to local private sector companies.

By end 1993, the majority shareholdings in 35 state-owned enterprises were sold, and another 30 were in various stages of divestiture. However, most of the significant enterprises were left out.

THE 43 SOES THAT WERE PARTIALLY OR FULLY DIVESTED YIELDED $102 MILLION.

SECOND WAVE OF PRIVATISATION IN THE 1990S

The 43 SOEs that were partially or fully divested yielded $102 million. But these were the ‘easy picks’ compared to the more complex service and utility sector divestitures implemented in the 1994-2000 period which generated about $403 million. Sri Lanka Telecom, Air Lanka and Colombo Gas Company were privatised in the latter half of the 1990s via sales to foreign investors who took over the management of these entities. However, in all these complex privatisations, the government retained a significant or controlling shareholding in the companies. The execution of these privatisations came from a strong political will to pursue complex reforms in sectors that had broader social implications which in turn was driven by the escalating deficits created by the war situation.

Post-2000’s the privatisation of Sri Lanka Insurance, and Lanka Marine Services took place. A strategy to gain political capital and public support for the process was lacking, which eventually led to ownership of these two ventures reverting to the state after court action. The UPFA government that followed in 2005 came to power with a manifesto that opposed the reform process of the previous governments. Privatisation was off the agenda until 2015. The new government found itself in a dilemma: budget pressures should have pushed privatisation back on the agenda-but with the pitch queered by the previous experience it shied away from reform. Instead of privatising or even reducing state expenditure, they resorted to taxes to cover the yawning deficit-which proved to be even more unpopular. Currency depreciation is putting the cost of living under even further pressure while corruption scandals have robbed the government of credibility. Citizens will need to wait for after the next election before the problems return to the surface. Perhaps then, the next chapter on state enterprises can be written.