An earnest tenderer for a building improvement at a public sector energy organisation, who arrived at 9 am spent the next six hours to collect bidding documents. Due to the risks associated with the pandemic, employees at some public sector organisations are rostered for work two or three days a week. The officers who eventually attended to the tenderer arrived several hours late carrying bags of groceries evidently having completed weekly shopping during work hours.
Being a small business owner, the tenderer patiently endured another delay to pay a Rs1,500 non-refundable bid deposit. Although the state organisation publishes documents online tenderers must bid on, the originals are collected after paying a bid deposit.
For most small businesses, and private and informal sector workers, Covid has been devastating. Private sector employees endured pay cuts, small businesses went bust and those in informal jobs were without an income during the lockdowns to prevent the Covid pandemic’s spread.
In contrast, public sector employees were unaffected despite tax revenues, which fund their salaries, falling from an average Rs145 billion a month in 2019 to Rs100 billion a month in the first eight months of 2020.
Unlike private sector workers, few public sector employees worked remotely. But their pay was unaffected although the revenue to pay it collapsed along with economic activity. Public sector salaries, pensions and other government expenditure were financed by borrowings.
Hollers of protests confronted the President’s Secretary – the senior most bureaucrat – when in the face of a growing economic crisis he suggested public sector workers donate a part of or a whole month’s pay to ease the pressure on debt management. He said the public sector’s salaries and incentives – including for those at state corporations, boards, banks and insurance companies – cost Rs100 billion monthly. In April 2020 when the request to forego a month’s salary was made, tax revenue was down to Rs70 billion, a level inadequate to cover that month’s public sector pay.
Stark inequalities in Sri Lanka’s employment landscape, accentuated by Covid, are now obvious.
As government tax revenue declined, up to August 2020, public sector workers and pensioners collected 84% of that revenue (chart 1) leaving little for everyone else. The amounts for public sector salaries in chart 1 exclude those at state owned businesses like banks and insurance companies, which are not funded by government budget allocations.
The state energy firm tenderer’s small business employs a couple of people. The entrepreneur and the staff will be included in what economists call the informal sector. In a report published in 2020 “Informality, job quality and welfare in Sri Lanka” by the World Bank, it says informal businesses account for 70% of jobs in Sri Lanka.
From a garage in a Colombo back alley that pays its mechanics in cash everyday, to sweatshops in backrooms of a family house packing sweetmeats, or a middle-class family paying their domestic aide in cash; all are in the informal economy. In some areas of the economy informality is the only profitable way to run a business.
The most informal sector in Sri Lanka is agriculture where 89% of workers fall into this category. Smallholder farmers – with a few acres of land – and tea and rubber plantation workers are all agriculture informal workers. Those toiling in the agriculture sector’s shadow are characterized by a large number of self-employed (48%) and unpaid family workers (18%).
In commerce and transport sectors too, the portion of informal workers is high (39% and 44% respectively).
According to the report, which has World Bank staff basing estimates on 2017 Department of Census and Statistics Labour Force Survey data, 5.6 million of the 8.2 million workforce toil in the informal sector. The Bank says that since 2006 – the first year such estimates were possible – the share of informal workers in the economy has not changed much.
The term informal sector itself is somewhat vague and applies to firms and workers that generally stand outside the tax and regulatory systems, but not synonymous with illegality.
Most informal workers are self employed according to estimates of labour force data (see chart 2).
World Bank estimates that of the 5.6 million informal workers, 2.5 million are self-employed and a further 1.6 million work in informal firms.
The lines between formal and informal are often blurry; many businesses are partly formal and partly not. Workers, who drift in and out of the workforce, also drift in and out of informality. Up to 750,000 informal employees work in formal firms. Others work as domestic servants or are unpaid family members helping in a business.
The World Bank highlights that public sector employment is entirely formal (chart 2). When only private sector workers are considered, the share of informal employment is nearly 80% (2.5 million self-employed, unpaid family workers – most of whom are women at 0.6 million, domestic aids at 0.05 million, and informal employees in informal firms 1.6 million and informal employees in formal firms 0.75 million).
The World Bank says informal workers can be classified in to several groups “depending on factors such as access to social security, employment status and the firm’s registration status.”
Sri Lanka’s labour market appears to be segmented into three strands (Chart 3) and the pandemic busting lockdown’s effects on them weren’t uniform. Incomes of public sector workers who account for 15% of those employed were unaffected by the Coronavirus (2019 employment data). In fact, some public sector workers received additional allowances during the lockdown and their salaries were paid earlier than usual, ensuring they faced no financial hardships.
Public sector workers – who all hold formal jobs – enjoy high remuneration, shorter work hours and many holidays, paid leave, other benefits, and overall high job security. After deducting all leave, holidays and weekends, a public sector employee works a mere 191 days. In other words, they work only half the days of the year (see chart 4).
For long, a myth that public sector wages are low has been perpetuated. As public sector workers only have to work half the days in the year, their hourly wages are the second highest in the employment segments in chart 2. Only formal self employed workers have higher earnings than public sector workers (see chart 5).
Private sector worker employment fall under one of two laws, the Shop and Office Employees Act (SOEA) or the Wages Board Ordinance (WBO). SOEA covers mostly services workers working from offices, and WBO covers mostly factory workers. SOEA employees have to work two-thirds of the days in a year while WBO employees work three-fourths of the days in a year (see chart 4).
Sri Lanka’s EPF and ETF are a form of social security for private sector workers. Unlike public sector workers their paid leave is limited and they work longer hours. The World Bank points out that private sector earnings distribution is closer to that of informal workers.
Economists don’t agree about what causes informality – some research suggests it’s a symptom of low growth while others argue that it’s the cause of low growth. They also variously blame high taxes and red-tape for making informality worse. Some workers also choose informal self-employment for its flexibility and also perhaps because they dislike authority.
However, the drawbacks of high informality are clear. A large informal sector is associated with low growth, low pay and poor-quality jobs (see chart 6). Informal firms pay measly wages and the jobs are tenuous. They also dodge both income and sales taxes.
Informality has three problems. The first is productivity. The second is poverty and the third is its impact on public finances.
Productivity at informal businesses has several facets. First, informal firms rely on informal networks for sourcing and distributing goods which leads to lower productivity and growth, leading to a misallocation of resources across the economy. Lacking access to credit also leads to economywide resource misallocation.
Second, high informality has a link to widespread poverty because the work is low quality, low paying and precarious. Workers aren’t satisfied with slogging away in the gray economy too, according to the World Bank which highlights studies that show informal workers are less satisfied with their jobs than formal workers. Many work informally because it is all they know.
Finally, the impact on public finance is due to small and not very productive businesses operating outside state regulation, where tax evasion is the norm. As a result, informality undermines revenue and fiscal sustainability.
Because low productivity firms are so commonplace, it means that the region is not getting the return it should from investments in education and infrastructure.
The typical Sri Lankan business limits itself to employing a few members of the family who do not receive a contractual wage. If the business does well the entrepreneur, unfamiliar and untrusting of the regulations, often chooses to limit growth because of the costs and risks.
In Sri Lanka, 23% of an employee’s earnings are directed to forced savings (EPF and ETF). While these savings are useful at retirement, it adds costs and cashflow pressure on small companies, who may be competing with informal businesses that do not have to bear these.
If due to an economic downturn, like the ones caused by the 2018 constitutional coup, the 2019 Easter Sunday bombings, or the 2020 pandemic, business were to suffer, salaried workers cannot be laid off by law!
The size of the informal sector may explain why Sri Lanka’s productivity is low despite its high educational achievements, universal healthcare, wide electricity availability, and good road access even in the remotest parts of the island.
Small businesses in general find it hard to innovate and expand. Firms will only move out of informality if they see the benefits of changing their ways. Governments have a role to play to make the formal economy more attractive. Formal businesses have long been highlighting that Sri Lanka’s employment laws discourage job creation. Businesses highlight two areas where laws need to change.
The first is that salaried workers cannot be laid off or furloughed for any reason. If trade dips and a company finds itself in difficulty it is more likely to go bust because it is unable to restructure. As a result, businesses in difficulty face dire choices.
Second, a business also cannot lay off workers who refuse to do their assigned work unless the business will compensate for the lost jobs. In practice, even if a worker refuses to do any work, behaves violently and disruptively or even steals or damages company property, laying off can result in a legal case and the need for a company to pay compensation. To avoid costly, time-consuming and energy sapping court proceedings, companies are often cowed down into paying compensation.
Some countries do impose severance costs on employers but Sri Lanka’s are the second highest in the world, according to the World Bank’s comparison of data (see chart 7). This is the third challenge with labour laws.
For the first five years of service, severance is two and a half months pay for every year of service (see chart 8). The formula extends up to 35 years of service, but subject to a maximum payment of Rs1.2 million.
The Employers’ Federation – an umbrella body of businesses that engages in employment related matters, recently informed its membership that the maximum severance amount may be doubled to Rs2.4 million by the government.
The World Bank says that, “maintaining both high severances pay and a formal social security (EPF) system can be prohibitively expensive for employers. Streamlining and simplifying labor regulations to lessen the law’s ambiguity, increase its transparency, and reduce overlapping coverage would make compliance easier and less costly. Enforcement efforts should focus more on mediation than on litigation, which can drastically increase uncertainty and costs for both workers and employers.”
Not all Sri Lankan managers speak up openly about the need for flexible labour laws, fearing such public utterances will make them and their companies unpopular. However, the anonymity of the World Economic Forum’s Global Competitive Index survey allows a franker assessment (Chart 9).
Of the top four problematic factors for doing business in Sri Lanka, two were related to labour: the poor work ethic of the workforce ranking second and restrictive labour regulations at fourth place. Executives have ranked the other factors as far less important than the first four.
For the first five years of service, severance is two and a half months pay for every year of service (see chart 8). The formula extends up to 35 years of service, but subject to a maximum payment of Rs1.2 million.
The Employers’ Federation – an umbrella body of businesses that engage in employment related matters, recently informed its members that the maximum severance amount may be doubled to Rs2.4 million by the government.
The World Bank says that, “maintaining both high severances pay and a formal social security (EPF) system can be prohibitively expensive for employers. Streamlining and simplifying labor regulations to lessen the law’s ambiguity, increase its transparency, and reduce overlapping coverage would make compliance easier and less costly. Enforcement efforts should focus more on mediation than on litigation, which can drastically increase uncertainty and costs for both workers and employers.”
Not all Sri Lankan managers speak up openly about the need for flexible labour laws, fearing such public utterances will make them and their companies unpopular. However, the anonymity of the World Economic Forum’s Global Competitive Index survey allows a franker assessment (Chart 9).
Of the top four problematic factors for doing business in Sri Lanka, two were related to labour: the poor work ethic of the workforce ranking second and restrictive labour regulations at fourth place. Executives have ranked the other factors as far less important than the first four.
In April 2020 when Echelon hosted Decodes, a webinar during the pandemic lockdown, Access Engineering’s Managing Director Christopher Joshua, Hemas’ then Chief Executive Steven Enderby, Hirdaramani Group Director Ranil Pathirana and Ashok Pathirage, Chairman of Softlogic Holdings, all suggested that flexible labour laws were the most critical reform the government could undertake to make sure businesses had a fighting chance to navigate the crisis.
Businesses mangers don’t exaggerate when they identify labour laws as impeding competitiveness of companies. When businesses can freely compete, consumers benefit with lower prices and for those companies that export goods or provide services overseas, they can grab larger market share because they are more productive. Business owners complain that onerous labour laws put them off hiring and push them towards temporary-employment agencies.
Employers who find labour laws thoroughly unsuited to a modern economy have had no reason to cheer before the pandemic or since. In fact, almost all businesses, reeling from no revenue due to the pandemic and no help, cut worker pay although the legal framework does not allow for that.
Tacitly the government now admits the coronavirus has exposed system faults.
The government, through the Ministry of Employment and Labour Relations, has supported an agreement also involving the Employers’ Federation and unions to pay lower salaries to employees who do not have work.
Meanwhile, the Department of Labour, publishing the findings of a survey of the coronavirus impact on Sri Lankan businesses, has suggested ‘measures to ease the financial burden on employers’. Of the short-term recommendations, one was for maintaining employment with reduced pay or what the department refers to as ‘short-term lay off ’, so that these employees may return to their full-time roles in the future.
The pandemic may peter out in 2021 as access to the vaccine increases. But the poverty and public finance crises – that can’t be entirely blamed on the pandemic – has only just begun.
Sri Lanka’s inequity in the employment landscape will hold back the recovery and growth because its informal sector is acutely vulnerable and unproductive. Around 1.1 million state workers, financed by all taxpayers enjoy all the benefits while sucking up resources enough to provide welfare for those whose employment is tenuous.
Informal workers and private sector job holders make less than half the hourly pay of public sector employees (see chart 5).
What has been missing is political ambition. To reduce informality and allow small businesses to flourish requires a more equal deployment of public resources (including for social protection when people lose their job) – flexible labour laws, and simpler tax and business regulations. That was the what the UNP government of 2015 promised when it came to power.
In 2018, a unified employment law that was approved by the Cabinet which consolidated the SOEA, WBO, the Maternity Benefits Ordinance, and the Employment of Women, Young Persons and Children Act into one labor law, without reducing any of the rights or benefits under the individual laws. It was a bold first step in reform, but was never approved by the legislature. As a result, the majority of Sri Lankan workers remain tenuously employed.