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Export growth and sustained development

29 Oct 2012 - {{hitsCtrl.values.hits}}

Following is the speech by Sri Lanka Economic Association President A D V de S Indraratna delivered at SLEA’s Annual General Meeting on the theme ‘Export Growth for Sustained Development’.

Sustained development is continuous high economic growth, with inclusiveness, over a long period of time - say six to ten years. Inclusiveness means equitable distribution of the benefits of development among the entire people of the country. Sustained development is necessary for the continuous improvement of the quality of life of a people. After all, this should be the ultimate aim of all development. High economic growth is necessary for sustained development but it is not sufficient without inclusiveness.

Economic growth is measured by the rate of growth of GDP, which is simply the rate of increase in the net value of goods and services produced within a country during a year. In the last half century (1961-2011), Sri Lanka did not have any period of sustained economic growth. In this whole period of fifty years there were only three years, 1968, 1978 and 2011 which had a growth rate of more than 8% (8.2 % in 1968 and 1978 and 8.3 % in 2011)

Historical background
The economy which we inherited from the British was trade - dependent. As long as the primary product prices were high and terms of trade were favourable, the country’s economy was considered prosperous.   This was the case in the first 8 eight years of Independence, 1948-1955. After 1955 economic conditions began to deteriorate: The value of exports which was as high as one third of the GDP began to decline with the growth rate falling, and unemployment rising. Gross official reserves were shrinking, with a foreign exchange crisis in the making. By the end of the fifties, the growth rate had fallen to as low as 1.5 %, unemployment had risen to more than 15 % of the labour force and gross official reserves had almost halved their 1955 level, adequate for only 3 months’ of imports (CBAR, 2011).

The centre-left and centre-right Governments came in to power alternately,   since the beginning of the nineteen sixties. They continued with the same policy of welfarism with huge consumer subsidies, at the expense of growth and stability. However, in order to arrest the deteriorating foreign exchange situation,   the former followed a strategy of import substitution in industry (ISI), while the latter a strategy of import substitution in agriculture (ISA). The consequences were disastrous. The economy was more or less stagnant, with the growth rate falling below 3 % and unemployment rising to unprecedented level.   All in all, within a period of two decades since 1957, Sri Lanka had become a highly restricted and regulated or closed economy. The economy which had derived around one third of its GDP from exports and diverted around one third of its domestic expenditure to imports, had by 1977 become 50 % more closed with exports contributing only 15 %, and imports accounting for 18 %, of GDP. Despite the pursuit of import substitution policies, the Governments had not been able to prevent the rise of imports relative to exports and the growing trade deficits and the worsening external imbalance of the economy.

The centre-right government which came in to power in mid 1977, adopted, as an alternative remedy, an open economy policy with liberalization of trade, and accepted export-led growth as its development strategy with the private sector as the engine of growth. What happened.? The growth rate almost doubled to 8.2%, and exports boosted from 18.7 % to 30.9 % of GDP, in 1978 over 1977. This was mainly due to the resurgence of investment and production activity which was lull or pent-up, and restoration or reconstruction of factories which remained closed, during the closed regime. High growth, however, could not be sustained, without sustained export growth, although subsequent centre-left Government continued with the open economy. As a trend, the growth rate was declining with exports falling, while imports were rising much faster, as a percentage of the GDP. The next century began with a negative growth rate of 1.5 % (in 2001),   the first time ever to have a negative growth.

The centre-left government had been in power since 1994. It is unfortunate that during their first decade in power, little attempt had been made to promote new exports, except garments, even which were highly import- intensive in the absence of a local value chain. Only lip service had been paid to the so called engine of growth of the private sector. There had been a continuing resource gap between gross savings and investment and this was manifest in the twin deficit of the budget and the current account of the balance of payments, both of which had been on an upward trend. Sri Lanka was continuing to lose the competitiveness of its   existing exports, due to the increase in upfront costs resulting from high inflation and high interest rates at home, on the one hand, and the overvalued currency or appreciation of the real exchange rate, on the other, both in the context of very low physical productivity. For example, tea and coconut, two of Sri Lanka’s premier exports lost   their markets   to their competitors like Kenya and Philippines respectively.

New vision
A new coalition government came in to power in 2005 with a Ten –Year Development Framework , “ Mahinda Chintana : Vision for a New Sri Lanka.” It assumed a bigger role than before for the government and placed a greater emphasis on the development of the domestic sector. Despite the biggest natural disaster ever of a Tsunami” in the preceding year, and the heavy price the country had to subsequently pay for reconciliation, rehabilitation and reconstruction, and intensification of the terrorist war, the economy was able to perform well in the four years of 2005-2008, with an average annual growth rate of 6.5 %, mainly because of the growing domestic sector. Unemployment was falling rapidly, official reserves increasing significantly, and FDI reaching an unprecedented annual level of more than US$ 800 million by the end of 2008.

However, this scenario could not be sustained, without significant growth in exports. Imports had continued to increase faster than exports; the trade deficit and the current account deficit had risen reaching record levels by the end of 2011 with the budget deficit remaining around 7.0 %, above the estimated figure. FDI was not able to reach even the 2008 level. The internal balance, which was maintained in 2010 and   2011 with a high growth rate of around 8 %, low inflation and low interest rates, also began to turn adverse.

All this while, the Central Bank had, with its intervention in the forex market by selling Dollars, maintained the over-value of the Rupee. The Government (the Ministry of Finance), no longer being able to resist the plea of the business sector for a realistic exchange rate to improve the competitiveness of exports, devalued the Rupee by 3 % in November 2011. 3 % was hardly adequate and the Rupee was still overvalued. The Central Bank stopped its intervention only in February, 2012, by which time it had drained away as much as US $ 3.0 billion of reserves. After the Central Bank stopped its intervention, the Rupee began to float and depreciate, until about the beginning of the last quarter of this year, when it seems to have stabilized around Rs.128 to the US Dollar, a fall of about 15 % over the 2011 end value.

Despite the depreciation of the Rupee, the growth rate continued to fall from more than 8 % in the last quarter of 2011 to 7.9 % in the first quarter, and to 6.4 % in the second quarter of 2012.   There was, however, one little consolation that imports had begun to fall faster than exports, and the deficits in the balance of trade and the current account of the balance of payments to consequently decline, in the first seven months of this year, even though the deficits still remained substantial. However, the budget deficit has continued to rise reporting 5.56% already in the first 7 months, and by the end of the year, is most likely to be more than the last year’s, and very much higher than the estimated 6.2%. This is a cause for worry.

Exports growth
The upshot of all what I have said so far is that sustained high economic growth is possible in a country like ours only with sustained growth in exports. Sri Lanka is a small country with a small domestic market unlike many of her Asian neighbours. If Sri Lanka wants to be globally competitive, she had to produce for a bigger market benefiting from the economies of scale. That is why she has to produce for export.   I do not want to further elaborate on this aspect, as it will be discussed in detail at the technical sessions tomorrow.

My concern here this evening is : why have exports not grown as envisaged in an open economy with export-led growth as its development strategy? why has the private sector not acted as the engine of growth as expected? Rupee devaluation would help a depressed export market, by increasing the rupee receipts for a unit of exports, but this by itself would neither help to enhance a country’s export competitiveness in a highly integrated global market, nor would it make the private sector act as the engine of growth.

Factors for sustained export growth
Enabling Environment : Sustained export growth requires the amelioration of a host of other constraints, with the active partnership of the private and the public sector. The role of the public sector lies mainly in creating the necessary climate and environment for investment and production for export by the private sector (Private sector here includes foreign direct investment as well). Firstly, it must provide the necessary infrastructure as the provider of public goods. Secondly, it must implement appropriate macro economic policies as incentive to production for export, such as tax holidays, low inflation and low interest rates. Thirdly, it must create an enabling environment with an efficient, honest, independent and impartial public service, ensure the prevalence of law and order and the operation of the rule of law in the country, and above all, good governance free of corruption and waste. Unfortunately, these are markedly lacking in our country.

Productivity : Another important factor is the enhancement of physical productivity or the level of efficiency of investment. The level of efficiency or productivity of investment has been very low in Sri Lanka in comparison with that of not only developed countries but also that of developing countries of Asia. This is particularly marked in her agriculture . Productivity depends mainly upon three factors, infrastructure both physical and social, innovation and technology.

Infrastructure provides external economies and increases efficiency of investment. In 2006-2010, the average capital-output ratio, which is a measure of the level of productivity has been in the order of 4.2 ( that is 4.2 units of capital or investment have been utilized to produce I unit of output) With the new infrastructure investment undertaken in Sri Lanka after the cessation of terrorist hostilities, productivity seems to have increased to around 3.5 in the six quarters ended in June 2011, as judged by the rate of investment and the rate of growth . The better is the quality   of the infrastructure, the more it will contribute to the enhancement of efficiency of investment.
Innovation can occur in any activity, but specifically applied to development, it covers new ideas, new or adaptation of existing methods, processes, new techniques which enable to produce more effective or value added or branded or differentiated products or services and creation of new or niche markets. Innovation falls in to two categories, organizational and technical. Both these are usually accompanied with increase in productivity, and thereby competitiveness or marketability of products. Since innovation increases the productivity of enterprises and the competitiveness and marketability of their products or services, it helps to achieve sustained economic growth. In sum, innovation is a catalyst of growth and a necessary condition for sustained development and, a priory, for sustained export growth. While the government creates an enabling environment, and provides the necessary infrastructure, the private sector has to be innovative to effect value addition, branding and differentiation of their existing produce, as well as diversifying their exports to capture new and niche markets. Regretfully, our business community, as a whole, has not been very innovative ( low ranking in the Ease of Doing Business Index). It has been trade-oriented rather than manufacture-oriented.

Technology : The level of Science and Technology is very low in Sri Lanka, as judged by the expenditure on R & D, the number of research institutions and researchers per million people and the percentage of high-tech exports. According to the available statistical data, R& D expenditure in Sri Lanka, as a percentage of GDP, is less than 0.2 % whereas in a middle income country like Malaysia it is more than 0.6 % and in a high income country like USA nearly 3.0 %. It is appalling that, of this 0.2 % GDP expenditure on R & D in Sri Lanka , the private sector which is expected to be the engine of growth contributes less than 1.0%. (with the Government contributing 67 % and foreign sources 23 %, and others, the remainder). The number of researchers per million people in Sri Lanka is 237 in comparison again to Malaysia with 510 and USA with 4630 . There also has been very little FDI coming in to Sri Lanka ( see below) with technology transfer, relatively to other emerging economies of Asia, such as China, India and Vietnam. Overall, in respect of technological sophistication and firm level technology absorption, of 102 countries examined, Sri Lanka has been ranked 66 and 62 in comparison with India,s    25 and 31 and Singapore’s 6 and 5 respectively . It is, therefore, no wonder that of the total exports of Sri Lanka only around 1.5 % comprises high-tech exports. Nevertheless, it is gratifying that an attempt is now being made by the Government to enhance nano technology and reportedly several ( not less than 50) nano-technology consumer products are now produced and marketed.

Trade Agreements is another factor which would impinge upon export growth. They could help by prompting diversification of exports with new products and new brands of products, particularly to make use of tariff concessions under existing bilateral trade agreements, such as those with   India and Pakistan. At present, we are able to make use of only a very small percentage of tariff lines under these agreements, because Sri Lanka just do not have the products classified under them to export. Sri Lanka should also come to some trade agreement with China to make better use of tariff concessions under the APTA. These would help to reduce the existing trade deficits with all these three countries.

Sustained export growth, on the one hand, requires the enhancement of competitiveness of exports with improvement of productivity, in the backdrop of a realistic exchange rate. Here is the critical partnership of the Government. On the other hand, the private sector must play a bigger role by investing a much larger share than now, in order to increase the capacity to export : this is where the role of the private sector as the engine of growth and exports as the driver of this growth, comes in to play. Let me say a bit more about Sri Lanka’s private sector as the engine of growth.

Private sector as engine of growth
The percentage GDP share of the private sector in total gross investment of the economy has not increased in recent years. Paradoxically, in fact, it has decreased. For instance, its annual contribution in the last 5 completed years (2007-2011) was 21.3 % of GDP, whereas it was higher with 23.6% in the preceding decade of 1991-2000. On the other hand the government contribution has increased by more than 2 1/2 percentage points to more than 6 % of the GDP, over the same period . What has gone wrong? Both parties, in my view, are to blame for not ameliorating the constraints for export growth which I have already mentioned.
The Government has a lot to do in creating an enabling environment, with good governance without waste and corruption, with law and order and the operation of the rule of law, the guarantee of citizens’ right to information, practice of simple rules and procedure in regard to both local and foreign investment (FDI) and reform of higher education with improvement of its quality and relevance to meet the skill demand of a growing economy with a higher budgetary allocation than now to higher education and R & D. The Government also must play its partner role as the provider of infrastructure services, facilitator, moderator and mediator as elaborated else where.

The private sector, as the bigger partner, must be more innovative and effective, and play the lead role as the engine of growth. It must put aside more for R & D and increase its share of the Gross investment to four times that of the private sector. Last year, while the Government contributed 6.3 %, the private sector contributed 23.7 %, of the GDP of a total Gross investment of 30.0 %. While the Government share can and should increase slightly to 7 %, the private sector ‘s share must be four times, that is 28 %, totaling a gross investment of 35.0% of GDP. At an investment efficiency or an investment/output ratio of 3.5, this would give rise to a growth rate of around 10 %.

The increase of the government sector to 7 % can easily be attained, with the elimination of   corruption, waste and ostentation. The increase of the private sector can and will come from the large retained profits/reserves of local enterprises, along with the increase in FDI, when the biggest constraint to them, the lack of a conducive business climate and an enabling environment, as described here, is rectified.

Direction of increased investment
Where could and should this increased investment go? We referred earlier to the relatively slow growth of exports and the widening trade and current account deficit. which have to be reversed for sustained growth. This requires the diversification of exports with new products, increased value addition and differentiation to existing exports, etc., and capturing new and niche markets. Overall, the private sector must be innovative and effective to be globally competitive and be able to promote sustained high growth. Our local enterprises have not been innovative enough except a few such as CIC Agribusiness,. the DSI Group and the Cargills Group which readily come to my mind. It is because of their extraordinary innovativeness, that Sri Lanka has today become an exporter of quality shoes even to India, instead of remaining an importer as in the past, in the case of DSI Group and CIC exporting things which would not have been earlier dreamt of.

There is   wide scope in further value addition to Sri Lankan exports. For example, there is still some rubber, which instead of being exported in raw form can be turned in to finished products or value added before export . Another area in value addition which the private sector might exploit is vegetables and fruits for Middle Eastern markets . The exportable surplus of them might increase with the implementation of measures for reduction of post-harvest losses. Another area for more investment is industrial products.. With more FDI also coming in, with technology transfer, the private sector must think of going in for more high-tech exports. There is also a great potential for diversification of exports to avail of the very large number of concessionary tariff lines open to Sri Lanka from trading agreements such as SAFTA ILFTA, PLFTA and APTA.

There is also much prospect for further investment in the fast growing tourism industry. A target of 2.5 million tourists by 2016 means a huge annual increase of more than 30 %. The Sri Lankan business sector has to invest in a big way to achieve this along with the big foreign investors.

Sri Lanka has ample fishery resources right round the island. Instead of allowing others to poach in our waters, the private sector must exploit them more fully for export. Minerals is yet another candidate for value addition for export.

ICT is another fast expanding area in Sri Lanka relatively to her South Asian neighbours. Accounting, Finance and IT/BPO has become a significant foreign exchange earner. It has a potential for further growth and the private sector must further exploit this.

Summary and Conclusion
Let me conclude my presentation with a note of optimism and pious thought. Sri Lanka is a fortunate country well endowed with natural and human resources. However, she has not been able so far to sustain high growth because she has not been able to sustain export growth eliminating   large deficits in her balance of trade and current account of the balance of payments. She is facing several constraints in this task. She will be able to overcome them, if the public and the private sector act in partnership in performing their respective roles efficiently and effectively.

The public sector must provide an enabling environment with good governance free of corruption and waste, and also make available the necessary public goods. The private sector must work with innovation, as the engine of growth, with exports as its driver. It must be more manufacture-oriented than trade-oriented. It must come forward to invest, up to 28 % annually, so that the gross investment of the economy goes up to 35 % of the GDP, with the share of the public sector remaining around 7%, and the annual growth rate sustained around 10 %. Both the rulers and the ruled must be simple, honest and patriotic to accomplish this task. If this task were accomplished and the goal attained, Sri Lanka would be doubling her per capita real income- I repeat real income- in about 7 years. This indeed would be a “wonder of Asia” in comparison with the East Asian Miracle of Korea which, in the sixties, had taken as many as 11 years to do the same.

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Export growth and sustained development

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