Impediments to Attracting Knowledge-Based FDI (Foreign Direct Investment) To Sri Lanka

ABSTRACT
Knowledge-Based Industries (KBIs) play a dominant role in the economic development of both developed and developing countries. In particular, they have been significant in generating economic growth, diversifying the industrial sector and improving industrial competitiveness. Therefore, many countries attempt to foster KBIs via the attraction of knowledge-based foreign direct investment (FDI).

KBIs are considered the backbone of the ‘knowledge-based economy’. Already some advanced countries, including South East Asian nations like Singapore, South Korea and Taiwan, have entered into an era of ‘knowledge-based economies’ through embarking on knowledge-based investments. The Sri Lankan government has also paid attention to the development of KBIs and a variety of policy initiatives have been introduced and launched in this regard. The Ten Year Horizon Development Framework (2006-2016) (Ten-Year Vision) issued in November 2006 envisages Sri Lanka to be a knowledge and service based economy. However, the major challenge that policy makers encounter is how Sri Lanka can develop and attract knowledge-based investments in a more competitive global business environment? This paper highlights the recent developments of knowledge-based FDI in Sri Lanka and impediments that Sri Lanka confronts in attracting knowledge based FDI. This also discusses policy prescriptions and how best Sri Lanka can take advantage of the available potential in attracting knowledge-based FDI. The scope of KBIs is very wide since it covers a variety of industries. Therefore, particular attempt is made here to limit the scope of this paper to Information Communication Technology (ICT) as a knowledge-based industry. The terminologies of knowledge based FDI and ICT are used interchangeably in this paper.

INTRODUCTION
Since the early 1990s, the role of knowledge has been significant in creating and sustaining industrial competitiveness and economic development (Maskel and Malmberg, 1999). Therefore, many countries are attempting to transform their economies towards Knowledge-based economies. The concept of Knowledge-based economy has been introduced to describe economies in which organisations and people acquire, create, disseminate and use knowledge more effectively for greater economic and social development (World Bank, 2006).

Promotion of KBIs is one of the major strategies adopted by many countries in order to achieve knowledge-based economy status. Knowledge-based industries are those that relatively utilise intensive inputs such as technology and human capital. Firms involved in activities such as pharmaceuticals, aerospace, health, biotechnology, telecommunications, information technology (IT), consumer electronics and medical equipments are considered KBIs (OECD, 2000).

Sri Lankan government has also placed greater emphasis on the development of KBIs. In particular, the Ten Year Horizon Development Framework (2006-2016) (Ten-Year Vision), issued in November 2006, envisages Sri Lanka to be a knowledge and service based economy. Emphasis on the attraction of knowledge-based FDI is one of the major strategies adopted by the Sri Lankan government to achieve this objective.

This paper reviews the current developments of the knowledge-based FDI in Sri Lanka and identifies the potential and impediments to attract them. As mentioned above, the scope of KBIs is very wide since it covers a variety of industries. Therefore, particular attempt is made here to review the growth of ICT related FDI as a knowledge-based FDI activity, in order to limit the scope of this paper. In this connection, ‘information and communication technology’ refers to a diverse but converging set of activities, which share a common concern with the creation, storage, processing and transmission of information in a digital form (Collinge and Srbljanin, 2000). This definition is applied in this paper to define ICT as a knowledge-based FDI activity. For the purpose of this paper, industries related to telephone/telecommunication network, software development, IT enabled services such as Business Process Outsourcing (BPO) and Knowledge Process Outsourcing (KPO) and other IT related service oriented industries are considered knowledge-based FDI.

This paper is organised as follows: Section two examines the key advantages/potentials available in Sri Lanka to attracting knowledge-based FDI. Firstly, this section analyses the overall foreign investment inflows, including ICT sector, as a prelude to the discussion on key advantages. Section three focuses on the impediments that Sri Lanka faces in attracting knowledge-based industries. Finally, section four provides the conclusion.

KEY ADVANTAGEOUS/POTENTIAL AVAILABLE IN SRI LANKA TO ATTRACTING ICT RELATED FDI

ICT has been recognised as the key to improving economic performance, productivity and greater efficiency, reducing transaction costs and allowing greater control of activities of business firms (Collinge and Srbljanin, 2000, Daniels, 2004). The rapid development of ICT has made it possible for many companies to become footloose. Back-office functions can now be conducted almost anywhere regardless of the geographical location of company headquarters (Dahlström, 2000). Due to these key features and new developments of ICT industry, efficiency-seeking (eg. Knowledge and skilled labour) global investors/companies are moving towards ICT related investments in order to maximise their profits, and are looking for new investment destinations. Sri Lanka can also tap these investments in ICT industry given the favourable investment climate and the availability of key advantages in the country.

The overall investment climate of Sri Lanka shows a substantial improvement in recent history. The inflow of FDI to the country, for example, is on an upward swing. Sri Lanka received US $ 287 million FDI in 2005 and this has been increased to US $ 734 million in 2007, indicating a 39% increase during the 2005-2007 period (Central Bank of Sri Lanka, 2007). Sri Lanka received the highest-ever level of FDI in 2007 surpassing the previous record level of US $ 604 million in 2006. This growth was achieved due to a combination of factors such as investment incentives offered by the Board of Investment of Sri Lanka (BOI), several overseas investment promotion missions undertaken by the BOI, constitutional guarantees on investment agreements, re-investments of the existing companies and BOI’s initiatives under the Nipayum Centre Programme to promote investments in less developed regions (Central Bank of Sri Lanka, 2006 & 2007).

One of the significant developments of the composition of FDI in Sri Lanka is that the investments in the manufacturing sector are at a decreasing trend. Table 1 shows that 47% of total FDI in 2005 originated from the manufacturing sector. However, the contribution of the manufacturing sector has decreased to 24% by 2007. This change is due to increased investments in the ICT sector.

The other outstanding feature is that the contribution of knowledge-based FDI (ICT related) is considerably increasing. In particular, FDI in the Telecommunication sector alone has grown from 38.9% in 2004 to 54.9% in 2007 (see Table 1). This growth is mainly due to increase of capacity of main fixed lines operators such as Sri Lanka telecom, Suntel, Lanka Bell and Dialogue and four mobile operators (Dialogue, Celtel, Mobitel and Hutch). As a consequence of the presence of these foreign telecom service providers, the number of mobile subscribers stood at around 8 million as at the end of 2007 (Central Bank of Sri Lanka, 2007). Consequently, the mobile telephone penetration rate (mobile connections as a per cent of total population) increased from 17% in 2005 to 27% in 2006. These developments led to an increase in the national telephone density (per 100 persons) to 37 by end of 2006 (Central Bank of Sri Lanka, 2006).

IT related FDI activities (computer software development, IT training centres, call centres and Business Process Outsourcing activities) have also recorded a slight growth from 0.8% in 2005 to 1.2 % in 2007 (see Table 1).

The overall contribution of knowledge-based FDI (telecommunication and IT related investments) has increased from 39% in 2005 to 56% in 2007, recording a 16% increase over the relevant period.

The above analysis shows that ICT related FDI activities exhibit an increasing trend in Sri Lanka. This emphasises the potential to attract more FDI into this sector, given the availability of a variety of competitive advantages. However, it should be noted that Knowledge-based FDI in Sri Lanka is limited only to telecommunication and IT/BPO related industries. The inflows of foreign investments in the fields of biotechnology, research and development (R&D) and pharmaceuticals etc, have not occurred because of the unavailability of a suitable investment climate for knowledge-based investments. The following section examines the growth potential available in Sri Lanka in attracting ICT related investments.

Knowledge: a decisive factor in attracting knowledge-based FDI
In the 1980s, the location decisions of many FDI firms were mainly based on the availability of low cost and unskilled labour (Fröbel at el, 1980). However, it is argued that although low cost and unskilled labour still remains a source of competitive advantage, its importance is diminishing in the attraction of FDI (Lall, 2000). Instead, ‘knowledge’ has become an important decisive factor in deciding the destination of contemporary FDI because knowledge is one of the most strategic resources for firms to innovate and improve their economic performance (Landvall, 1994, Benner, 2003). As a consequence, there has been a switch in the global FDI from resource-based (natural-asset seeking) (e.g. low cost labour) FDI to knowledge-based, export oriented FDI (Dunning, 2001). To tap these knowledge-based FDI, Sri Lanka’s knowledge sector offers opportunities for growth, particularly given Sri Lanka’s good track record in literacy and secondary education enrolment (World Bank, 2008).

Further, Sri Lanka’s workforce has many knowledge related competitive advantages such as a solid mathematical background that translates into a solution driven approach to software development, competitive wages, high productivity, creativity and hand to eye coordination. Such knowledge related advantages provide a conducive environment to attracting knowledge-based FDI to Sri Lanka.

Recent developments in ICT infrastructure
Developed information infrastructure facilities are a pre-requisite for the attraction of investments to the ICT sector. After the privatisation of Sri Lanka’s telecommunication industry in 1997, a variety of new, faster and more efficient communication technologies have been developed in Sri Lanka such as Code Division Multiple Access (CDMA), Short Messaging Services (SMS) and dual band and multi Media Messaging Services (MMS). Further, Sri Lanka is connected to the SES-ME-WE 4 international fibre-optic submarine communication system, which was launched on November 22, 2005. This facility connects South East Asia to European countries through the Indian Sub-continent and Middle East. These modern telecommunication facilities operated by several service providers make the industry one of the most competitive in Asia (World Bank, 2008). Sri Lanka has now emerged as a regional hub for telecommunications.

Emerging destination as a Centre of Excellence (CoE) for financial and accounting
Sri Lanka has been recognised as one of the emerging destinations as a CoE for Financial and Accounting Outsourcing by Tholons, a US based outsourcing consultancy and investment firm (ICTA, 2007). For the first time, Sri Lanka was included in the 2007 Global Services Location Index Survey conducted by the global IT consulting giant A.T.Kearney. This report analyses and ranks the most common remote functions, including IT services and support, contact centres and back-office support and reveals the relative cost advantage of the leading offshore destination. Sri Lanka was ranked 29 among the top 50 nations in 2007 (www.atkearney.com). The A.T Kearney report highlights that Sri Lanka offers many of the same advantages as India, with similar labour costs, widespread use of English, strong education systems and an increasingly open and well-regulated business environment, indicating that Sri Lanka is a potential destination for location of IT/BPO related industries.

Confidence placed by leading foreign companies
The international investor community has already placed its confidence in Sri Lanka by investing in ICT industry. Sri Lanka has been able to attract world-renowned companies engaged in sophisticated ICT related activities. Some of the international operators in the telecommunication sector are NTT Japan, Bharti Airtel (India), Telekom Malaysia, Celltel (Sweden), Millicom (US), Telia AB Sweden, Nortel of Canada, Hutchison Whampoa HK, and VSNL India. In addition, Sri Lanka has been able to attract leading international IT related firms (see Table 2). These firms are engaged in a variety of activities including conducting market research, high-end investment research outsourcing, human resource management and development solutions for overseas clients.

Strong institutional presence
Since the 1990s, scholars and sub-national governments have placed emphasis on the development of local ‘institutional capacity or ‘institutional thickness’ in order to foster and attract foreign direct investment (Amin and Thrift, 1994; Storper, 1997; Martin, 2000; MacKinnon and Phelps, 2001; Wood and Valler, 2001). It is argued that fostering and ’embedding’ of foreign investments is heavily dependant on local institutional capacity (MacKinnon and Phelps, 2001; White, 2004; Fuller, 2005). In this connection, institutions are useful to embed ‘footloose’ industrial firms in a specific location and reduce their tendencies for relocation. Institutions also help to lower the risks, enhance competitiveness of existing firms and enhance innovative capacities (Yeung, 2000).

Sri Lanka provides a sound institutional support, both public and private, with regard to the development of ICT industry. A variety of institutions are in existence, which are dedicated to the development of ICT industry. Some of the prominent agencies involved in catering to ICT industry in Sri Lanka are given below according to their orientation.

i. Policy formulation institutions:
Information Communication Technology Agency of Sri Lanka (ICTA), Computer Society of Sri Lanka, Telecommunication Regulatory Commission of Sri Lanka (TRC).

ii. Education/Training institutions
The University of Colombo School of Computing, University of Moratuwa, The Sri Lanka Institute of Information Technology (SLIIT), National Institute of Business Management (NIBM), Charted Institute of Management Accountants (CIMA), Institute of Charted of Accountants (ACA) and Association of Computer Training Organization

iii. Associations
Computer Society of Sri Lanka (CSSL), Sri Lanka Association for the Software Industry, Software Exporters Association.

Additionally, moves are underway to establish an umbrella organisation for the IT and BPO sectors, utilising the highly successful benchmark established by National Association of Software Service Companies (NASSCOM) of India.

iv. ICT related infrastructure development institutions
Sri Lanka Telecom Pvt Ltd, Board of Investment of Sri Lanka (BOI) and Telecommunication Regulatory Commission of Sri Lanka (TRC).

The presence of these specialised institutions fulfils a variety of needs of the investor requirements and they provide a boost to the development of ICT industry in policy formulation and capacity building. As highlighted above, some of these institutions train and produce qualified ICT graduates and develop manpower skills at all levels to meet the growing specialist labour demands of the country. One of the fundamental competitive advantages enjoyed by foreign firms has been the ability to employ qualified graduates. The high level of interaction among these institutions (both public and private) has led to greater efficiency in the industry.

Attractive investment incentives
Sri Lanka also offers attractive investment incentives to investors engaged in the ICT industry. A tax holiday ranging from 3-12 years, duty free import of capital goods and exemption from exchange control (if export oriented) are some of the lucrative incentives offered by the BOI. These incentives intensify the growth potential of attracting ICT related FDI.

The presiding analysis discussed the potential available to attracting FDI to the ICT industry in Sri Lanka. However, in order to intensify the growth prospects further, it is necessary to address the bottlenecks, which hamper the growth of the ICT industry and make Sri Lanka unattractive as a destination for locating knowledge-based FDI. Therefore, it is useful to identify the impediments that Sri Lanka confronts in attracting ICT related FDI. The identification of these bottlenecks will be useful to policy makers to introduce and implement suitable policy initiatives in promoting ICT related FDI.

IMPEDIMENTS TO ATTRACTING KNOWLEDGE-BASED FDI TO SRI LANKA.
Knowledge-based economy status acts as a magnet to attract knowledge-based industries. The following bottlenecks can be identified as issues to improving the investment climate with regard to ICT industry.

Low investment in education and training
The successful development of KBIs in many regions (eg: Silicon Valley, Bangalore) is mainly associated with the number of supportive policies, in particular, the development of human capital (skilled labour force, training provision, financial support and higher education and research). The learnings/experiences from the above regions indicate that a positive relationship has been found between the development of human capital and attraction of KBIs. Such regions have invested heavily on human capital development. Sri Lanka’s human capital development needs to be strengthened in an attempt to attracting KBIs. Sri Lanka faces a shortage of the human capital needed for more knowledge-based economic development. The expenditure on education has been decreasing in Sri Lanka and it is now equivalent to about 2.5% of GDP lower than in most comparable countries (Asian Development Bank, 2007). As a result, university education is lagging. Some 125,000 students qualify to enter national universities each year. But universities can only cater for only 20,000 students annually (not more than 15% of those qualified for university education gain admission) (Central Bank, 2007). Even those 15% have to face a supply driven university education system, which has little relevance to labour market requirements and entrepreneurial culture. This creates a mismatch between labour supply and demand. The other major problem is that about 65% of the students admitted to local national universities study social sciences and humanities (Central Bank, 2007). In China, 50% of students at university level study science or technology related subjects (World Bank, 2008). Neighboring India turns out nearly two million graduates per year with over 120,000 engineers, which place the country in the focus of BPOs much more than Sri Lanka (Sri Lanka Business Standard, 2008). These issues prevailing in the education system reduce the potential for the attraction of KBIs to Sri Lanka.

Insufficient English language skills
Although Sri Lanka’s literacy rate is significantly high when compared to many other Asian countries, the proficiency in English lanugvage remains low in Sri Lanka. English language skills have become the most skill requirement for the BPO sector. The supply potential workers with good English speaking skills remains a bottleneck to the development of the BPO sector in Sri Lanka (World Bank, 2008, Sri Lanka Business Standard, 2008).

Slow growth of Science and Technology
The development of Science and Technology (S&T) has been more influential in attracting knowledge-based FDI in many countries. Developed countries such as the UK, USA, Germany, Japan, Korea and Malaysia have been able to attract significant amount of knowledge-based industries due to the developed R&D facilities. In the developed world, GDP contribution to R&D falls between 2-3% where in the developing world it is often not even 1%. In Sri Lanka, this was 0.3% in 1996 and has decreased to 0.19% in 2000 (Department of National Planning, Sri Lanka, 2006). India spends on R&D activities about 1.1% of GDP and cities like Bangalore have become not only leading centers for IT but also increasingly specializing in value- added R&D services. As a result of the development R&D infrastructure (e.g Bangalore Software technology Park), India has been able attract many multinational corporations such as Texas Instruments, Intel, and Motorola who are engaged in R&D functions (Parthasarathy and Aoyama, 2006). Some of the key issues experienced in the S&T sector in Sri Lanka are weak scientific infrastructure, limited investment in scientific research, inadequate personnel and lack of science culture.

Lack of communication infrastructure
Telecommunication infrastructure is one of the fundamental requirements to the growth of the ICT industry. Although the telecommunication sector remains one of the fastest-growing sectors in Sri Lanka, a number of infrastructure deficiencies can be experienced in the telecommunication sector. For example, Sri Lanka outperforms other South Asian countries and Vietnam in teledensity (telephone per 100 people), its service standards compare poorly with those in other East Asian countries. The average wait for phone connection in Sri Lanka, at 61 days, is more than four times that in China, Malaysia, and the Philippines (World Bank, 2005).

High telephone costs
It is pointed out that telecommunications costs are considerably high in Sri Lanka in comparison to comparable countries. Telecommunication services are one of the major requirements for the growth of IT enabled BPO services. It is pointed out that after human resources, the second highest expense faced by BPO industry in Sri Lanka is telecommunications with costs averaging around 22% of total monthly costs (World Bank, 2008).

High connectivity charges and low usage of internet
The price for internet connection in Sri Lanka in 2004 was almost twice as much as the price in India, and more expensive than those in China, Malaysia, Thailand and Philippines (Wolrd bank, 2008). Sri Lanka’s price basket for 20 hours of internet amounts to $ 25.28, more than four times the cost in Malaysia (World Bank, 2008). The high prices limit connectivity and restrict IT literacy.

As a result of this high connectivity prices, Lanka’s internet usage is far behind neighboring countries. For example, as Table 3 illustrates, the internet penetration rate in 2007 was 2.2% of the total population in Sri Lanka while it was 47.8% in Malaysia. Similarly, Vietnam and Philippines recorded 20.6% and 16% internet user penetration rate respectively. Vietnam’s internet user penetration rate has increased by 20% from 2000-2007 while in Sri Lanka, this has increased from only 2% during the same period. This shows that Sri Lanka’s growth in internet usage is still poor.

Lack of ICT professonals
The lack of ICT professionals has been one of the major impediments to the growth of KBIs in Sri Lanka. In particular, experienced middle and upper level managers are lacking in the areas of software design, project management and software business consulting (www.icta.lk). It has been estimated that about 5,755 IT graduates are needed annually. But only 2216 IT graduates were added to the workforce in 2007 (Sri Lanka ICT Association, 2007). This shortage is due to two reasons. Firstly, the intake of IT graduates in the national universities is not high. Secondly, ‘brain drain’ occurs at a rapid rate in industries such as IT, accounting, financing, banking and travel (ADB, 2008). Many IT qualified graduates find job opportunities in countries such as USA, Australia, UK Middle East and Canada creating a shortage of skilled manpower.

CONCLUSION
The evidenced presented in this paper suggests that knowledge-based FDI in Sri Lanka is mainly confined to ICT related industries (telecommunication and IT/BPO). Although, Sri Lanka exhibits basic key advantages in attracting ICT related industries, the impediments discussed above outweigh the key advantages. Sri Lanka may miss the opportunities available in attracting knowledge-based foreign investments unless correct policy measures are formulated and implemented. Particularly, attention should be focused on few major areas, i.e., to improve information infrastructure, to improve education system and intensify R&D activities.

In this connection, information infrastructure plays a significant role. As pointed out earlier, current issues such as high telephone costs, connectivity charges, low internet penetration rates, and lack of IT professionals could retard the growth and attraction of investments.

The investment on education should be enhanced in a rational manner and the structure of curriculum of universities of the country should be changed according to the market orientation. At present, approximately 65% of the university students follow social science and humanities related subjects in Sri Lanka while in China, 50% of students at the university level study science or technology related subjects. This shows that Sri Lanka’s university education system is not yet geared towards global demand. The expenditure on education has to be further strengthened.

In creating a conducive environment for knowledge-based industries, the development of R&D culture is also important. Although, FDI in this sector is currently negligible, there is scope for the development of R&D services given the strong presence of institutional framework. Initially, what we require is to improve linkages among private sector, universities and research institutions.

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