5th December 1999

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Firm nudge for corporate governance

By Mel Gunasekera

A recent Colombo Stock Exchange survey shows that only around 4.8% of the country's savings are mobilised through the stock market.

In comparison, commercial banks dominate domestic savings with 71.2% of the total, while the National Savings Bank mobilises 20.0%. Finance companies trail behind with the stock market mobilising just 4.0%.

Stock Exchange chief, Hiran Mendis said that the 4.8% figure includes monies invested by promoters which accounts for little over 2%.

"If you take the promoters contribution out, you are left with just 1.2% by foreign and 0.8% of monies generated through local investors."

In addition to this, most companies tap inhouse resources like retained earnings, but earnings via stock market accounts for around 1%, he said (see table).

"Even in our best year, which was in 1994, we accounted for only 10% of savings.

Mendis says a lack of transparency is partly responsible for the poor response of investors and shareholders from investing in the market.

"Despite having the most modern technology, the exchange has had a poor record of mobilising savings," he said addressing a recent seminar on 'Corporate Governance' organised by the SEC.

Mendis said that the poor rate of savings mobilisation through the SEC goes to prove that good governance has not gone down the line.

He said that 25% of listed companies don't maintain their minimum 25% public float.

"This goes to show that public companies in Sri Lanka are not really public. When we talk to potential investors, private companies feel there is the need to control. Their companies are not comfortable with outsiders. Issues of corporate governance is a means of making things comfortable. If you run things openly, you can run with little shareholding."

Mendis says that he wants companies to look at corporate governance as a way of promoting good economic sense. "It should not be done because of a code, a fad or because the exchange or SEC wants it to. It should be looked upon as a mechanism that makes good economic sense."

In an attempt to stimulate market activity and boost flagging investor confidence, the Securities and Exchange Commission (SEC) is requesting the listed companies to incorporate corporate governance into their management structures.

Though the SEC directive is voluntary, Director General Kumar Paul told the Sunday Times Business that he hopes the initiative would bind company directors into incorporating corporate governance, as well as create investor and shareholder demand for this.

Corporate governance deals with the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment.

Sri Lanka was one of the first countries in South East Asia to embrace corporate governance in 1997. The Institute of Chartered Accountants of Sri Lanka (ICASL) under the chairmanship of Mr. Nivard Cabraal brought out a code of best practices on the financial aspects of corporate governance.

SEC Director General, Kumar Paul says that the Commission is requesting companies to disclose in their annual reports as to how far they have progressed in applying the code of best practice.

He said that the circular on governance will also include a few draft statements to give some guidance to the board on what shareholders and investors would like to see.

"We want to sail under the flag that corporate governance makes good economic sense, so we hope to issue the circular within the coming days so that this will be included in the annual reports commencing from December 1999," he said.

Additional monies received from

- promoters 70%

- DFI's 16%

- commercial banks 8%

- stock market 1%

- others 5%

(Source: CSE)

Thumbs down for Act

By Dinali Goonewardene

The tourism industry has given a thumbs down to a draft act to establish a Tourism Authority. The Authority will replace the Ceylon Tourist Board. The legal draftsman has released a draft of the act replacing the Ceylon Tourist Board with a Tourism Authority but the draft contains certain provisions which industry officials are keen to change.

"The Tourist Hotels Association of Sri Lanka, The Sri Lanka Travel Agents Association and Inbound Travel Agents Association co-operated with the Tourism Ministry in putting forward views on the Tourism Authority but the draft act does not represent these views," former Chairman, Ceylon Tourist Board and Chairman Serendib Group, Asker Moosajee told The Sunday Times Business. "We seek to make proposals to the Tourism Ministry to amend the act as they have asked for representation," Moosajee said.

Moosajee said a particular area of concern was that the new Tourism Authority would inherit the Ceylon Tourist Board which should be tempered to suit a private sector organisation. "The Tourism Authority should also be exempt from the Finance Act which would take away the freedom to act speedily and efficiently as the Authority would be bound by the rules that govern government organisations," he said. The draft act stipulates the Tourism Authority must be governed by the provisions of the Finance Act of 1971.

"The draft Act provides for the Tourism Authority to take over the employees of the Ceylon Tourist Board which brings it back to the same square," Moosajee said.

The draft act states that all contracts entered in to by the Ceylon Tourist Board (CTB) will be considered contracts of the Tourism Authority and all property of the CTB will be vested in the Tourism Authority. All court actions and proceedings instituted against the CTB will also be the responsibility of the Tourism authority.

The Act says that the Authority will have its own fund for which revenue will be accumilated by means of a contribution levy on all people operating tourist services, registered under the act. Donations from local and foreign sources and money voted by parliament for the authority will also be used.

Strumming it out in the heat of the moment

Has it ever occurred to you that heavy metal was the mother of all industries? Not the metalica and Guns n Roses stuff, but steel. And for the first time in Sri Lanka a company is strumming it out, steel that is. HIAT Steel is the only steel mill in the country to make its own billets (one meter square steel bars-considered a raw material) which recently was awarded an SLS certification, for the production of concrete reinforcement bars. The company melts scrap metal in an eight tonne arc furnace at blazing heats of over 1680 degrees centigrade. 10,000 amps of electricity pass through three human sized electrodes to melt the scrap metal into a molten cocktail. And within four hours the hard steel flows like melted butter. Samples are taken to test and control the chemical composition of the steel. Then the molten solution is poured into a machine that rolls out a continous bar that is therafter cut while it remains red hot. The cut bar is known as a billet and the billet is consequrently re -heated and rolled out into concrete reinforcement bars. The company produces 1000 tons of steel a month to supply the 180,000 ton a month local market. Many new innovative features have been introduced into this mill to make it an efficient and eco -friendly factory.

However the industry is now in-between a rock and a hard surface since the government has issued licenses for steel mills to be set up and the production capacity of all of them put together exceed local demand by nearly 2000 tons. Mr Milroy Fonseka, Project Director of the company (seen in picture) said that the only other company to have an SLS standard was the former Sri Lanka Steel Corporation.

The company began operations in 1990 and was only the third steel mill in the country, but now it is in company with 13 others. The factory was set up at a cost of approximately Rs260 million.Mr Fonseka said that they were working towards achieving ISO 9002 certification next year.

Nations' Trust Bank focuses on cradle to nirvana packages

Sri Lanka's newest entrant into the commercial banking sector, the Nations Trust Bank (NTB) will focus its activities on retail banking services, targeted at the above average income-earning segment, a top company official said last week.

NTB's product portfolio will be featured with personal loans, private banking facilities, credit cards and housing mortgages, with technology playing a critical role. The bank will also work with nurturing a close relationship with leading professional associations to provide a better targeted banking service to the high income earners, NTB CEO, Anura D S Gunasekera said in an interview.

As a part of its corporate strategy, NTB will also launch three fully-fledged branches next March in Kollupitiya, Kotehena and Kandy. Gunasekera says they hope to come to the market aggressively together with the launch of their in-store banking concept in five supermarkets next year."Our aim is to add value to our customers by taking banking to the people," he said. The concept is aimed at high net worth customers who wish to do their banking in comfort.

NTB hopes to cross sell products for instance, if a family wants a housing loan they can obtain one at the supermarket at their convenience. The products are tailor-made to enable the official to give their approval. Gunasekera says, that the main success is to make decisions on the spot and the staff have been handpicked and highly trained for it.

"In-store concept costs one fourth the cost of a fully fledged bank. we hope to pass the cost savings to our customers by way of low interest to loans and high interest paid on deposits," he said.

"We want to come into the market with our products aggressively with the in-store bank. The launch will be staggered between six weeks," he said. NTB has put together attractive 'cradle to nirvana packages' as part of their personal banking services.

Personal banking has been broken into different stages like 18-25 years (aspiring young people), 25-45 years (professional achievers) and 45-55 years (mature age looking for investment savings options).

NTB wants to offer a bundle of services for all age cycles like insurance and leasing facilities.

On the corporate banking sector, Gunasekera says they are targeting progressive entrepreneurial businesses, middle level accounts and large corporates.

An 'entrepreneurial business centre' will be launched at their new Kotehena branch. Corporate banking on the other hand, will also tackle the high end of the market. Gunasekera says their internet banking concept would include things like making it easier to apply for loan applications.

A prospective applicant can first go to their website and type in their income details.

The server will then calculate the interest rate and the repayment period and transfer the details to the bank branch, which will enable the customer to then discuss his loan application with the bank's loan officer.

Despite NTB's strong backers and the vast network of potential clients, analysts say it will not be easy for the bank to break long standing customer loyalty to existing banks and gain significant market share.

It is likely to take at least two to three years to further develop the degree of trust required to penetrate the market and earn satisfactory returns on investments. The bank's operating costs are also expected to be relatively high in the near term due to increased staff wage and training costs, high marketing expenditure and the likely need for attractive interest rates in the short term.

NTB will further have to incur significant capital expenditure in its bid to provide a technologically superior service.

Even with the existing clientele of OTB, analysts believe that NTB will do well to achieve deposit and advance targets of Rs. 1 bn within its first year of operation and a modest net profit in the region of Rs. 25 mn.

Growth is however expected to pick up in subsequent years as NTB becomes better known in the market via innovative produces, superior services and increased customer reach. However, Gunasekera did not want to disclose financial details, and instead opted to say that the Bank was very much on track with their performance.

No affair with EVA as yet

Local companies evaluated using Economic Value Added (EVA) may appear to be destroying value. Issues relating to EVA were the focal point of a CIMA seminar conducted by Mr Alan Rosling, Chairman, Jardine Matheson Group, India.

EVA is a single period measure of business profitability and is arrived at by deducting the capital charge from net operating profit less adjusted taxes.

Mr Rosling raised the question as to how popular a ratio EVA was in Sri Lanka . He said a recent study concluded in India revealed that corporate India in aggregate had destroyed value in recent years.

"EVA is not used much in Sri Lanka and is not really understood by many people," Chairman of the Accounting Standards Committee, Reyaz Mihular said.

However research arms of stock broking companies use this measure in evaluating companies.

EVA can also be used in budgeting as a strategic performance measurement tool as a valuation technique by analyst. It can also be used in an executive reward system or acquisition analysis. EVA adds a focus to efficiency of capital use and can be calculated by firm, product, geography, customer, supplier or strategic option. It is an intergrative tool across business processes.

However EVA has its disadvantages. It is a profitnot cash measure. It can encourage short term focus and a bias against investment as depreciation is not stripped out.

It can favour absolute profit against a rate of return and can become a complicated number exercise.

A rubber bounce expected again?

There are a few hopeful signs that rubber prices may bounce up again. At the November 23rd auction Latex Crepe No. 1 crept up to Rs. 62.75 per kilogram. This was a one rupee increase from a fortnight before and about a ten rupee increase from the prices fetched five months ago. The worst impacts the natural rubber industry faced in 1998 appears to be receding. A cautious optimism appears appropriate.

Rubber prices have been declining recently. The FOB price, which had declined from Rs. 79.78 in 1996 to Rs. 75.42 in 1997, fell to Rs. 67.22 in 1998. The Colombo RSS grade 1 price fell to below Rs. 50/- in 1998. Several factors were responsible for the decline in prices. In recent years there has been an over supply of natural rubber in the main producing countries of Asia - Malaysia, Indonesia and Thailand. The decrease in petroleum prices resulted in a decreased cost of production of synthetic rubber, a close substitute for natural rubber. In addition to this the problem was aggravated by a release of natural rubber stocks by Thailand. The East Asian crisis impacted in two divergent ways. The demand for motor vehicles and other rubber goods declined, while the depreciation of the Asian currencies resulted in sharp decreases in prices.

The price declines last year were so serious that they dipped below the cost of production. Smallholders suffered severe short-falls in income, while estates suffered losses. The current up trend in prices is likely to benefit the rubber dependent smallholder cultivators as well as result in profits for rubber growing plantation companies. Yet a question mark is whether the recovery would be adequate to support long term development of rubber cultivation.

The decline in international rubber prices was so severe that Sri Lanka imported 259,869 kgs in 1998 and 270,891 kilograms in 1997. True these imports were less than one per cent of our exports, yet they were occasioned by a currency development rather than an inefficiency of the industry. The question is whether the current import duty of 10 per cent and an effective rate of about 16 per cent is adequate protection under the circumstances.

The three developments which lend hope to a recovery in natural rubber prices are the rise in petroleum prices, the economic recovery of South East Asian countries and the appreciation of their currencies. Petroleum prices have increased quite sharply from the levels of 1997 and 1998 and adds to costs of synthetic rubber production. The rise in synthetic rubber prices would enhance natural rubber prices. Improved demand for tyres and other rubber based goods should not only improve natural rubber prices but also the profitability of rubber manufacturing industries.

The volatility of rubber prices has had an adverse impact on rubber cultivation for many years. Rubber production, which was on a plateau, dipped sharply in 1998. Rubber production which was 113 million kilograms in 1996 fell to 106 million kilograms in 1997 and to only 96 million kilograms in 1998. In the 9 months of this year rubber production increased by 2.6 per cent from the low levels of last year and is likely to be around the 1997 figure of just over 100 kilograms. The question which arises is whether the government should enact measures to stabilise rubber prices or support rubber production through some means so as to withstand periods of depressed prices. Without such measures it is likely that rubber production would be on a long term production decline.

The government must make a decision as to whether natural rubber production is an important national economic activity. If the answer is in the affirmative then it should protect it from undue fluctuations in prices and support a long run development strategy. More than 50 per cent of our rubber production is now used by our industries. This is a healthy development and must be encouraged as increased domestic consumption would tend to stabilise rubber prices.

The up trend in rubber prices is a welcome relief to rubber producers. Yet fluctuations in rubber prices are inevitable and periods of depressed prices are a threat to long run productivity on rubber lands. A development strategy for rubber must recognise price volatility and develop a framework of policies to deal with the external price trends so as to ensure long run development of the rubber industry.

The role of government in economic development

By Nadeem U. Haque
Origins of state activism in the Third World

Colonial administrations in the Third World cultivated the image of the state as the ultimate benefactor of the people as a means of facilitating their own survival. Favours of the state became an important means of winning political support and loyalty. An ally could be rewarded and an enemy could be neutralized by the offer of a title, land, or a government contract. Once the notion of the state as benefactor had taken root, the local population became dependent on the state, accepting the role of the latter as an agency for allocating the colony's economic resources. The colonial state often looked suspiciously on any private activity that developed outside official sphere control because such independent initiative could represent a challenge to state authority, both as an example of independent initiative as well as because it might result in the accumulation of capital, on which the state sought to maintain a monopoly so as to facilitate the colonial power's control over the indigenous population

As the role of the colonial state expanded, local population increasingly lost their ability to take initiative and came to rely on the state for even the most minor of matters. They tended to develop the attitude that the state was the ultimate arbiter of their economic fate. The deputy commissioner1 or some similar minor government functionary, therefore, came increasingly to control their lives, and they turned to him for more and more of their needs. This dependence stifled initiative and innovation. Community self-help, individual pride of achievement, and co=-operative endeavours, all severely atrophied.

As the notion of the state as a benevolent deity became entrenched, any concept of a social contract between the state and its citizens, which forms the intellectual basis of democratic institutions, tended to be discarded at the popular level. The state could be kind enough to bestow some favours on individuals, but there could be no expectations from the state. It would have been subversive in this environment to suggest that the reason for having a government at all might be to provide certain public goods and services for the people, such as security, a legal system, economic infrastructure and a healthy environment.

Thus the old Kennedy saying was fully in effect: "Ask not what your country can do for you but what you can do for your country". Ironically, in spite of the origin of this quote, the average American is always watchful of where his tax dollars are going and frequently raises the question with his leaders and representatives. On the other hand, people in post-colonial societies rarely hold their governments accountable for the economic implications of state actions

This lack of government accountability has also characterized the views of intellectuals and economists in these countries. Steeped in the English Labour Party philosophies of the mid-twentieth century (in South Asia and Anglophone Africa), in the French technocratic tradition (Francophone Africa), or in indigenous Structuralism (Latin America), these individuals have been quick to make the assumption that the state can and should have a large role in the economy. Despite historical evidence to the contrary, they have assumed that the state plays the role of a benevolent deity, above the fray of everyday economic and political life. In this role, the government is above reproach. Such intellectuals seldom stop to examine whether government actions have indeed succeeded in practice in influencing the allocation of the nation's resources toward socially desirable ends

Most development economists, both foreign and indigenous, share this intellectual tradition. In technical jargon, they perceive the existence of a "planner's problem" to be solved in determining how society's scarce resources are to be allocated, and assigned to the state the role of using its policy tools to ensure that the economy produces the right allocation.

They see the government alone as capable of achieving the desired progressive objectives of redistributing wealth and income, promoting basic industry, increasing the socialisation of production through direct public sector participation in the production of goods and services, and so on.

A number of social welfare arguments are used to support their case. The poor illiterate masses are perceived as incapable of helping themselves; therefore the government must provide for them. As their benefactor, it needs to feed, clothe, educate and look after the health of the poor.

The rich, on the other hand, are perceived as too rich and overly fond of conspicuous consumption. Thus, equity considerations require the government to redistribute income. The private sector in developing countries is often viewed as short-sighted and incompetent or monopolistic. As such, it has little, if anything, to contribute to economic development. The aims of such thinkers are laudable, and these economists are undoubtedly genuinely motivated by their concerns for the poor. However, by failing to hold the public sector to account, they may be acquiescing in a situation in which resources channelled through the government flow from the poor to the rich, while shrinking the size of the pie for all concerned.

The contemporary economic role of the state in developing economies

As a result of such views, the state has come to play a very significant micro-economic role in much of the Third World. A large fraction of the typical developing country's resources are channelled directly through the government. In part, this takes the form of public provision of certain services, such as education and health, a phenomenon which is also common in industrial countries. Additionally, however, the ownership of many factors of production (i.e., land, natural resources and capital) has been retained by the state and consequently public sector enterprises account for a large share of GDP. These include not only the traditional natural monopolies such as utilities, but also extractive industries, "heavy" industries such as steel that are perceived as "basic", the transportation and communication industries and many types of manufacturing activities.

Even in activities that are left in the private sphere, however, the state tends to play a dominant role. Tariffs, quotas, subsidies, export taxes and marketing boards regulate international commerce and domestic economic activity is often subjected to a long list of restrictions. These range from mild ones such as zoning restrictions, to price controls, to license and fee requirements, to the outright prohibition of many activities.

In all these ways, the state has come to play a prominent micro-economic role in developing countries, the daily lives of people being affected in a very important and significant manner by the government. Much of social and economic activity is in one way or another affected by government policy or intervention: the education that children receive, the way people drive, the layout of communities, the quality of water and electricity supply, as well as the price and availability of many goods are all in one way or another affected by the government. The government thus affects the environment in which the business of daily living is conducted in a pervasive way. Because of this large and important role of the state, the manner and the efficiency with which the government conducts its business directly affects the productivity of the rest of society.

The record of public sector performance

In this setting, the questions that need to be addressed are whether the government has delivered on all that has been asked of it in developing economies and whether it can conceivably do so, even in principle. The answer, unfortunately, would have to be a resounding "no" on both counts.

As to the past experience with government performance, instances of massive public sector failure abound in the Third World. Consider, as one of these, the fate of the government-regulated commercial banking system all over the developing world. Through controlled interest rates and subsidised, directed credit, banks have been made into institutions for delivering gifts to the rich and well-connected - cheap loans, often at negative real interest rates, which are frequently not repaid. These gifts to the rich are financed by low interest rates paid on the deposits of the poor, who do not have the option of holding their wealth abroad and earning international rates of return, as well as by outright subsidies financed by various forms of regressive domestic taxation. In many countries, the banking system, which the private sector was managing rather efficiently, was nationalised. Over the years, the nationalised banks in several countries have virtually been driven to bankruptcy through the mechanisms described above.

Education provides another notable example of public sector failure. For example, in Pakistan, for over thirty years, in keeping with the views of many development thinkers, the government was the sole provider of education. Despite many plans developed by the government and their resident economists/scholars and despite wasting considerable public funds on an overgrown education bureaucracy, neither the quality nor the extent of education improved. In the late seventies, the private sector was allowed to set up schools and an almost instantaneous and rapid growth in the number of schools occurred in almost all urban centres thereafter. Although there is a large variation in quality among these new schools, it is fair to say that on balance the new private schools have served to improve both the availability and quality of education in the country.

Regarding the question of whether the government could, even in principle, do everything that is asked of it, the answer again has to be no, for two reasons. First, and most familiarly, the information required to fulfil all the functions of the market is simply not available to the government. Economic planning has simply not proven to be feasible at the micro-economic level in the Third World, any more than it did in the former Eastern Bloc countries. The existence of a plan both for the short-term and the long-term supposes that the government and its experts, resident or otherwise, know what needs to be done and how it should be done better than the rest of society. They know the goods that need to be produced, how they should be produced and the prices at which they should be distributed, better than the consumers who demand, and the producers who produce, those goods. Because of this superior knowledge, the government sets up licensing schemes, provides subsidies and other incentives and allocates preferential credit. These assumptions have, however, been repeatedly falsified by unsuccessful government planning efforts

But perhaps more importantly, the fundamental problem is that the existence of greed is not restricted to individuals in the private sector, self-interest is found among public servants as well, and an over-ambitious micro-economic role for government simply creates too much scope for private individuals to feed from the public trough by appealing to the self-interest of those in public service.

When the government limits the scope of an economic activity by administrative fiat, for example, the restricted few who are permitted to engage in the activity received economic rents, and the acquisition of such rents becomes a prize for which private individuals will compete by doling out favours to those in a position to allocate the rents. Similarly, the levying of taxes and subsidies will inevitably attract the attention of those who will ultimately pay the taxes to receive the subsidies. The expenditure of private resources in the attempt to influence such public decisions - i.e., rent-seeking activity - is not only directly wasteful of the private resources devoted to the purpose, but if successful will also undermine the very purposes for which the restrictions, taxes, or subsidies were created in the first place by altering the criteria on which allocation decisions are made. Perhaps more importantly, when such rent-seeking activity is perceived by the public to be successful, the legitimacy of the government is undermined. This will impair its effectiveness in other areas.

Rent-seekers, who rely on government licensing and the protection it offers, on subsidies, and on the availability of low-cost credit that is expected to be converted into a grant, are frequently not interested in operating a business enterprise over the long haul. Hence, industries that emerge as a result of such activities often are found to be "sick" quite soon. High rates of taxation and excessive import barriers result in considerable resources spent by enterprises on either bribery or evasion, both of which are wasteful activities.

Distortions such as these, that have been induced by government policy, have served to create monopolies and preserve the wealth and privilege of the elite. An important adverse side effect has been that this policy has helped stifle financial markets in developing countries. An active stock market and an actively traded stock serve to exercise some discipline over the management of a business. Moreover, a well-functioning stock market draws the savings of the small saver into the most productive areas of the economy, thus enhancing economic growth. In many developing countries, because resources are transferred to the wealthy by means of government patronage, there is no need for businesses to approach financial markets for additional resources. Instead, they can easily use the influence their local power-broker has with a publicly owned bank or financial institution, or with a private bank forced by interest rate controls to allocate credit administratively. Consequently, businesses remain locked under the control of families. The stock market value of the company seldom reflects its true value, nor do the shareholders get their proper share. The result is that neither is the market able to exert its discipline on management, nor does the small saver invest fully in the development of business and industry.

What applies to administrative restrictions, taxes and subsidies, may be true a fortiori of direct public sector production and non-government public organisations (NGOs). Public enterprises are not subject to the discipline of the marketplace, as they are often granted tariff protection, subsidies and cheap credit. Thus managers and employees of public enterprises often themselves receive rents in the form of wages, salaries and benefits out of all proportion to what they could earn elsewhere. In fact, running a public enterprise, or working for one, becomes a plum to be awarded to the favoured few.

A recent approach to the problems of the public sector in developing countries has been to create autonomous public sector agencies intended to work towards specific economic objectives. These non-government organisations, NGOs, however, often reflect the standard government response to a perceived problem - to make the budgetary allocations, create a new agency and appoint some government favourite as a chairman. An organisation is born, the chairman and his favourites have perks and money to spend and no responsibilities or accountability. Years go by and little is achieved accept that the budgetary allocations for the new organisation are increased each year. However, despite the increase in expenditures, the organisation does not increase its productivity. In fact, in many cases, apart from broad guidelines laid out in its charter, no attempt is ever made to even define the productivity of such and organisation.

The deficiencies of public sector performance are not simply a symptom of endemic inefficiency or corruption in the Third World. Indeed, the private sector has repeatedly shown itself to be capable of substantial innovation and efficiency throughout the developing world. Often choked by excessive government regulation, however, it is forced to operate outside the pale of government influence in the informal sector, which in many countries is now regarded as the engine of growth. Where regulation has been eased, the private sector has often responded fairly strongly.

The private sector is not infallible either, of course. Private companies can and will fail frequently. The difference is that when they do, their failure is often socially useful in a world with imperfect information and the resulting losses are borne by those who have chosen to venture their capital. In the case of a government-run organisation, the public does not discover the extent of the loss that is being incurred, or the fact that their taxes are paying for it, until it is too late. Thus the losses persist for a far longer period than they would, if the money were coming out of the owner's pocket. Consequently, unless the government largesse is involved, only profitable and efficient private firms survive, contributing to the economy and to employment, while an inefficient government firm that continues to drain the budget is extremely hard to kill.

Rethinking the role of the government

The thrust of the argument above is that an over-ambitious micro-economic role for the government in developing countries has resulted in enormous inefficiency and resource wastage in the countries that can least afford it. Moreover, this cannot be easily remedied through administrative tinkering or political change, because the problems are inherent in the way the government's economic role has been defined in these countries. What is needed is a fundamental, radical rethinking of the role of government in these countries, with a view to defining that role so as to maximize the efficiency of resource use in the economy as a whole.

In defining any role for the government, we must begin with an assessment of the current capabilities and quality of the government. At present, the government in many developing countries is truly in a state of crisis. Aside from the problems described above, the state is now in a position in many developing countries that it cannot even deliver on one of its most important and most fundamental functions, that of protecting life and property. This is a function of the government that has been understood since times immemorial, even in old tribal and feudal societies. Even in the provision of basic public goods such as sanitation, clean water and other basic necessities, the government has not been able to keep up the earlier minimal standards that were set in colonial days. The growing ineptitude of governments has been combined with rapidly increasing levels of corruption and nepotism. The result is that the government is incapable of functioning according to any norm that we might consider desirable from the social standpoint. Before asking the government to set any policy goals or take on any new task, then, we must bear in mind this near paralysis of government as currently structured.

The objective of a rethinking of the role of the state should be to achieve efficient government, so as to promote aggregate efficiency.

Nadeem U. Haque is the Senior Resident Representative IMF in Colombo


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