Crony capitalism must be replaced by market capitalism to attract FDI

From Sunday 08/06/2014 Island
by R.M.B Senanayake

Last week Minister Lakshman Yapa Abeywardene spoke about foreign direct investment (FDI) in glowing terms. FDI is a major catalyst for development and we as a heavily indebted country seeking to raise the level of investment in the country to over 30% needs such investment.

FDI is usually sought to augment the shortfall in domestic investment. Our national savings are only 22% of the GDP while the required investment is 35%. Economic development requires a certain level of investment and in our case the required target is 35% to produce sustainable growth of 8% which we had in 2010 and 2011; on an incremental Capital/Output ratio of 4.5. So FDI is a vital necessity.  It is a more reliable source of foreign capital than foreign debt capital or foreign inflows into the stock market.

FDI also increases access to world markets and competitiveness of the local economy and brings in valuable new management techniques and technologies. So governments are keen to attract FDI to increase production and exports. We have set apart special Economic Zones where facilities are given for duty free imports of raw materials for processing and re-export of goods. They are given tax holidays. But there is an approval process which takes time.  It was intended that the Authority in charge of the Special Economic Zone would be a one stop agency so that permissions required from various local authority and other regulatory authorities would be vested in the same authority.    But there has been criticism that such FDI may not really reduce imports and that domestic investors may be at a disadvantage where the foreign enterprises are allowed to sell a part of their production in the domestic market. There is also criticism about the environmental impact of FDI. But overall, the increase in FDI flows to the country is beneficial.  

How to attract FDI

But it is not easy to attract FDI to a small country which constitutes only a small consumer market and which lacks natural resources whose processing produces profit opportunities. We are not attracting FDI from the multi-nationals. They have invested $2 trillion in Asia but hardly anything here. So special less stringent strategies are needed in matters like environmental standards, labor, and competition, intellectual property rights (IPR) to attract FDI.  Above all corruption must be eliminated to attract large FDI. FDI has to be competed for and wooed. It will contribute most fully to sustainable development when the underlying economic, social and environmental governance policies in place are adequate.

But we have put in place crony capitalism and not market capitalism. Who are these crony capitalists? Economists refer to rent seeking. Rent normally accrues only to land. But when businessmen get access to business opportunities through an uncompetitive process where the decisions are based on political influence only, there is rent seeking. The industries which gain access through political influence are accompanied by bribes to provide the investors with a sheltered business without competition. Often they are the only firms in the business and are monopolies which give them super profits. The Economist magazine says "China’s billionaires in whatever industry are often chummy with politicians and get subsidized credit from state banks. President Premadasa was known to phone the two State-owned banks and direct them to give loans to businesses men who won his favor.

Some industries are particularly susceptible to rent seeking. They range from telecoms to infrastructure such as cement, steel and other heavy industry manufacturing projects. India’s legal system is trying to jail a minister accused of handing telecoms licenses to his friends. We too hear allegations of ministers taking bribes or commissions. But unlike India there seems to be absolute impunity for graft here unless the particular minister falls foul of the powers that be when the law will be put into action. Some think that a class of crony businessmen has rigged the country’s economy and the stock market. Industries that are prone to graft are those where entry or access is not freely available. Government owned land and assets may be handed over to cronies on favorable terms with part of the loot going to the ministers or those in power. These crony businessmen grab a bigger share of the economic pie rather than making the pie bigger. Economic rent is the difference between what people actually pay and what they would have to be paid for their labor, capital, land or any other input into production, if there was open transparent bidding. So deals are often done in secret without any open process such as a tender. The excuse given is that tenders take too much time. Deals are allegedly done by family networks.

It is because of this graft and crony capitalist business deals that large FDI investors are not coming into corrupt emerging countries. However, there are growing opportunities for FDI from India since Indian investors are looking for countries with Free Trade arrangements with India. We must improve both the conditions we offer to investors and improve our position in the Doing Business Index.

Policies toward attracting FDI are no different from policies for mobilizing domestic resources for productive investment. The intelligentsia thinks we have a deeply rotten state; a crooked police; suborned courts and a corrupt public service- all elements for a failed state. We need improvements of the general macroeconomic and institutional frameworks; restoration of the Rule of Law, the creation of a regulatory environment that is transparent and non-discriminatory and not on political favoritism;

The late N.U Jayewardene realized that the inordinate delays and long drawn out processes in our civil courts was detrimental to business. He campaigned successfully for the setting up of a separate Commercial Court for Colombo. Economists have come up with recommendations for cutting short the dispute resolution process in civil courts which we can make use of.  The Chicago School of Law developed economics and the law. A vast range of legal issues have been scrutinized by economists who have come up with unique solutions. Many economists appear in courts in USA as expert witnesses. The combination of law and economics has been most fruitful in the anti-trust field and in insider trading in the stock market. The World Bank too has entered the field of judicial reform realizing the importance of the legal system and its efficient functioning for promoting economic growth.

There is a close connection between the functioning of the legal system and investment in the economy both domestic and foreign investment.  Our legal system does not provide speedy solutions.  There are inordinate delays in both the civil and criminal justice systems. We saw how the British national who was killed and his girl friend raped in Tangalle by a powerful politician was not arrested or charged promptly by the authorities. It is only international pressure that seems to have worked in charging those VIP accused. But such impunity will set a bad example for foreigners whether they come here as tourists or businessmen.

There seems to be a wave of serious crime sweeping the country. Some people think the solution is to implement the death penalty. But it is not the penalty or punishment itself but the certainty of the punishment following the crime which is the deterrent. What affects the decision of the criminal is the probability of being caught and then being hauled before the courts and convicted. What is the probability of being convicted?  In Japan such probability is 95% while here it is below 5% according to the previous Chief Justice Sarath Silva.

There are thousands of criminal cases which are pending in the courts. Nobody knows how many cases are in arrears. But is the government doing anything about clearing these arrears? The Minister of Justice seems to be more concerned about his political party than in expediting the administration of justice. Corruption is said to prevail in the court registries.  It is said there is also graft in the minor judiciary. The process of administration of justice depends on the judges, the lawyers and the back offices of the courts. The Minister of Justice should look into the matter of the laws delays. Of course he should not interfere with the dispensing of justice which is a matter for the judges. But shouldn’t judges be given a monthly performance target to complete cases? It is necessary also to improve the back offices. The minister obtains the funds from the budget and he owes it to the people to see that the courts function efficiently. The Marga Institute did a study of the courts some time back and their report stated that there was much graft and corruption in the courts. The minister should go through that report. The combination of graft and administrative inefficiency can be grotesque. This will have to be change to attract FDI.
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