International Economic Trends and Growth and Structural Change in Sri Lanka

by Professor W. D. Lakshman


1. Let me begin with a kind of tautological statement. Being a small country, Sri Lanka had experienced in the past that the weight of two types of factors in influencing both: (a) the patterns of growth and structural change in the country; and, (b) economic and social policy postures adopted by different regimes at different times since political independence was more or less evenly balanced:

  • externally generated developments, and

  • domestic political, social and ideological trends.

2. Having tried out various policy formulae, Sri Lanka since 1977 is adopting a strategy of growth and structural change which:

  • is broadly within what are globally known as IMF and World Bank programs of stabilization/structural adjustment

  • has been guided under loan conditionality provisions of these two institutions

  • has been underwritten through financial assistance from these institutions and the world donor community, and

  • has been adopted in Sri Lanka by a regime which has been (a) ideologically committed to such a market-oriented, private sector dominant strategy, and (b) influenced by the "failures" of a different package of policies which consisted of extensive state controls involved a high degree of public sector dominance of productive activities and was of an autarkic orientation.

3. The thrust of the currently adopted policy package is to integrate the Sri Lankan economy into the world economy and world market relations. Hence the emphasis on the following elements:

  • promotion of export oriented activities. These include not only commodity exports but also various other exports or foreign exchange earning activities, some of which, emerging through private profit motive, could even be prohibited/discouraged by law/administrative practice.
  • search for a realistic exchange rate for the rupee to maintain international competitiveness, this having amounted to, so far, a consistent depreciation of the rupee since 1977. (This is likely to be the case also in the forseeable future.)

  • policies of import liberalization (virtual elimination of quota restriction and reduction of tariffs) and liberalization of exchange payments

  • promotion of direct foreign investment, the establishment of a central administrative agency for the purpose (GCEC) and a number of free trade zones, promotion of the establishment of foreign banks and off-shore banking facilities, tax and other attractive incentives for foreign investors, non-intervention in labor markets to facilitate the prevalence of a low-wage economy, opening up the emerging domestic stock market to foreign operators and making available large public sector enterprises to foreign companies for "purchase", attempts to develop Colombo as an international financial center.

4. I may note, in passing, the concept and the rhetoric of a "two-legged" development strategy since about 1988. Policy measures noted above constitute those intended to promote self-employment, micro-enterprises, etc., among which the janasaviya program holds politically the key position, constitute those intended to promote the rather weak and largely political second leg. The rationale for the second leg may be found in the adverse social and political implications of the operation of the first leg. I would argue that the eventual success of the current overall economic strategy to achieve real socioeconomic development would be fundamentally dependent on success of the first leg to achieve its long-term objectives. Until that happens (hopefully), some of these elements in the second leg of economic policy may turn out to be useful, in the short and the medium runs, to keep at bay the agitational movements of the people against the short and medium term sacrifices they have to make in the pursuance of policies in the first leg.

5. The success of the first leg would depend anyway, to a large extent, on what happens in the rest of the world and the adequacy and speed of domestic responses to such world developments. Normally, one would expect Sri Lanka to be able to benefit from "advantages of being small". But today, in respect of its current economic strategy, there is a special factor which Sri Lanka should take cognizance of, i.e., the presence of a very large number of small and big countries in the developing world within similar stabilization/structural adjustment programs, which are in the process of promoting similar goods and services for export. The implications of this special factor will be dealt with in greater detail later. The non-recognition of this factor may amount to the commitment of what we call an "error of composition".

6. The international economy is well known for its vicissitudes or the trade cycle ups and downs. Many analysts seem to believe that the vicissitudes of the world economy over the recent past have been taking place around the trough of a long-term cycle or a Kondratief cycle. World output growth which fluctuated widely since the mid-1960s have been at a very low level over the last few years (1988: 4.1%; 1989: 3%; 1990: 2.2%). In 1991, the performance in a number of major economies in the world, including the traditional fast growers of Japan and Germany - was faltering. Along with these development, world trade growth also declined (1988: 8.5%; 1989: 7%; 1990:5%). Realistic predictions for 1992, as per both output and trade, are not at all bright.

7. In terms of the geographical pattern and commodity composition of world trade, the following points are quite well-known:

  • dominance of developed market economies (DMEs) in world trade (around 70% at the end of the 1980s);

  • dominance of manufactured goods in total world trade (around 75% at the end of the 1980s);

  • more rapid growth of manufactured exports even from developing countries;

  • extremely unequal country distribution of manufactured exports from developing countries.

8. There are a few important points for the present discussion emanating from the above. Sri Lanka, in its current stage of export-oriented industrialization, remains as a country exporting predominantly labor-intensive products using simple and mature technologies (particularly garments).

  • world trade growth in respect of such product categories has not been very rapid - less than the average for all manufactured goods;

  • markets for these products are concentrated in DMEs, the growth of whose output and import trade has been sluggish;

  • arising out of employment-related domestic pressures, there are, in these markets, strong and increasing protectionist pressures against cheap imports from developing countries;

  • as already noted, Sri Lanka is not alone but is a small one among a large number of developing countries at similar stages of development engaged in active promotion of the export of similar product categories.

9. All these tell us that the competition to stay ahead of others is much stronger today than a decade or two ago when only a few small countries in the world went along this path and achieved, over time, successful socioeconomic development through world market integration. This competitive race is joined by the reformed former socialist countries also. The importance of buoyancy in the world economy and the world trade for the success of this kind of strategy cannot therefore be over-emphasized. This condition is not likely, as we noted earlier, to be met adequately in the near future. In that situation of continually sluggish growth of the world economy, the domestic production sectors must be able to register consistently rapid productivity growth. The prospects without such rapid productivity growth are rather alarming for the ordinary citizens of the country. It should then lead to a downward spiral of "exchange depreciation leading to inflation leading to further exchange depreciation". This would be a good recipe for a decline in real wages and the continuance of the pattern of concentration of benefits of export-oriented growth in the hands of a fortunate few.

10. To complete the discussion, I must bring existing and prospective conditions pertaining to foreign direct investment (FDI) and other international financial flows including foreign aid into the picture. Although there has been some contribution from more developed developing countries to the world stock and flow of FDI (the so-called Third World multinationals) these stocks and flow are still dominated by DMEs (97% of the stock in 1988). The dominant hosts for these investments too are the same countries in the world. Two-fifths of the current stock of FDI in developing countries is in the Latin American and the Caribbean regions. While growth of FDI flows to Asia, in recent years, has been more rapid, most of the FDI flowing into that continent has been going to East and Southeast Asian Countries. With economic liberalization of countries like India, China, Vietnam and the massive demands made for such foreign capital by Eastern Europe and the countries which formed the former Soviet Union, the likelihood is one of increasing competition among developing countries for the small volumes of FDI available for inflow into those countries. A small country like Sri Lanka will continue to enjoy the advantages of being small in this respect also but the fact must be stressed that attracting FDI is going to be increasingly harder than in the past. Also, if one believes (as I do) that to enhance "national benefits" from private profit-oriented FDI, there should be monitoring and guidance of it by the national authorities of host developing countries, then this increased competition among many similarly placed countries for the limited flows of available FDI may be considered as going against this requirement. Monitoring and guiding needs will then be ignored in the competitive scrambling to attract more.

11. International financial flows expanded massively in the 1970s and the first half of the 1980s. International lending grew twice as fast as world trade. A significant share of the increase in lending came .from Japanese banks. Already by the early 1980s, with the second surge in oil prices and an increasingly severe world market crisis (in which world market interest rates rose to unprecedented heights), many developing countries (DCs) were finding it difficult to service the mountain of debt they had accumulated. These difficulties, and the growing threat of default, led to a dramatic fall in the growth of lending to DCs. Disbursements from external borrowings by DCs declined from almost US$110 billion in 1980, when commercial bank lending to DCs was at its height, to US$91 billion by 1989. Net transfers to DCs went from a positive US$37 billion in 1980 to a negative US$1 billion in 1989. While commercial bank lending to DCs has declined, a few DCs in Asia and Latin America have managed to secure a growing flow of foreign, mainly developed country, equity funds. As a result, international portfolio investment in DCs has grown rapidly, from negligible levels a few years ago to about US$2 billion in 1990. One of the adverse consequences for many DCs of the increasing internationalization of financial flows has been the uncertainty arising from greater fluctuations in exchange rates and interest rates in DCs, have had a detrimental impact on their economies, which have been only partly compensated for by official capital flows from DMEs and multilateral agencies.

12. In 1989, official development assistance on highly concessional terms accounted for two-thirds of new resource flows to low income countries and four-fifths of flows to the poorest countries. The volume of aid extended by member countries of the OECD bilaterally and through multilateral channels rose by an annual average of 3% in real terms in the 1980s. This was in line with the average annual growth rates of their economies. Some member countries, such as Germany, the UK and the US reduced their aid as a proportion of GNP while others, such as Denmark, France, Italy, Norway, Sweden and Switzerland increased it. As a result, aid-GNP ratios of OECD countries remained about 0.35% throughout the 1980s.

13. The aid outlook for DCs in the immediate future is uncertain. On the one hand, political and economic developments in Eastern Europe and the former Soviet Union countries are likely to result in a significant diversion’ of aid flows away from developing countries. On the other hand, the reduction in superpower tensions and the likely corresponding decrease in military expenditures by OECD countries should result in a marked release of resources from unproductive uses which could increase the available quantum of aid and boost world output.

14. Economics, as a discipline, has been called in a quite well-known quote, "a dismal science". I do not wish to conclude, following that tradition, by being "a prophet of gloom". As a small country, Sri Lanka has been obtaining large and increasing inflows of foreign capital in the past 13-14 years. The news now available about the outcome of the just concluded Paris aid group meeting appears to provide confidence to the domestic regime that international capital continues to place confidence in the economy of Sri Lanka, willing to underwrite the policies initiated in the late 1970s. The inflow of private foreign capital for FDI projects, though not at the levels of those into countries of East and Southeast Asia, are nevertheless not insubstantial. Inflows of private foreign capital for stock market investments has, in recent times, been particularly impressive. Thus there are reasons to be optimistic regarding prospects for the "first leg" of Sri Lanka’s current strategy. The intention in my preceding comments has been to stress the need to temper this optimism with caution. Cautious optimism is something we should have and euphoria, what we should avoid.

15. Let me conclude by pointing out one more aspect of the matter which further emphasizes the need for caution in our desirable optimism. Due to time limitations, I have deliberately chosen to focus only "economic growth and structural change" in this presentation. The capitalist mode of production appears to be, even in this last decade of the twentieth century, capable of promoting growth and structural change more effectively than any known alternative pattern of accumulation and resource allocation. But as found elsewhere, in Sri Lanka too, the expansion of capitalism is found to be disruptive of traditional social structures and to be leading to excessive inequalities. Peace and harmony, the absolute essentials for the success of any package of policies, could be seriously undermined by these developments if not properly managed. The need for a properly guided regulatory state cannot thus be overemphasized.

[This paper was presented at the 23rd CCA-URM Committee Meeting, 11-15 February 1992, Colombo, Sri Lanka.]