**31 |** P a g e

promotion may be counterproductive and costly reducing the chances of a country’s participation in the division of labor built around global supply chains.

Considering asymmetry in Sri Lanka’s geographical trade patterns with the bulk of exports going to MFN markets and a sizable portion of imports (around one fifth) coming from preferential partners, mainly India, the economic rationale behind a preferential agreement would be to attract FDI and encourage Sri Lankan firms to take advantage of preferential conditions in access to India’s markets. Indeed, Sri Lanka could become a gateway to South Asia for foreign investors: but paradoxically this calls for the reduction in multilateral protection and deepening of regional preferential agreements.

High duties, which are particularly steep for processed goods and dispersion of tariff rates, create a strong anti-export bias and suppress competition from imports that is critical to improvement of productivity.

Sri Lankan foreign trade regime has an inbuilt anti-export bias: high levels of protection artificially encourage allocation of capital to protected activities discouraging the development of new products and export diversification as well as establishing of local networks supplying directly or indirectly exporters.

# **3.  Exemptions from domestic regulations and their implications**

Proliferation of exemptions always testifies to weaknesses in an economic regime. The weaker a regulatory regime is, the larger a need for finding ways to exempt actors from its reach in order to minimize economic losses or remove disincentives to otherwise desirable behavior. Dualism is an inevitable product of fundamental weaknesses in Sri Lanka’s foreign trade and private sector regimes.

Total nominal protection rates erect almost insurmountable barriers to imports despite cascading tariff rates increasing with the level of processing. High rates on imported inputs raise production cost to the level making production internationally not competitive unless the government provides relief from them. Restrictive imports regime imposes taxes not only on imports but, as the Lerner symmetry theorem shows, also on exports thereby reducing country’s total trade. The negative impact may be to some extent made up for by regulatory dualism differentiating between export-oriented businesses and those producing for domestic consumption. Predatory tax administration and other measures contributing to costs of doing business in Sri Lanka being much higher than for firms in countries directly competing with Sri Lankan firms require measures that would level the playing field through offering exemptions.<sup>32</sup> A strict implementation of tariff and para-tariff schedule would bring exports using imported inputs to a halt and full-fledged enforcement of the domestic regulations related to taxation and investment

> 32 Tax rates and tax regulations have been ranked by businessmen in various international surveys as most problematic areas of doing business and they have been more burdensome than in  most countries at a similar level of economic development (see various issues of the World Bank’s Cost of Doing Business as well as the companion volume to Cost of Doing Business prepared by the World Bank in cooperation with PricewaterhouseCooper titled _Paying Taxes 2011: The global picture_ , International Finance Corporation and PricewaterhouseCoopers International Limited, Washington D.C., and London 2011.