SL growth profile: Arrest moving down the staircase immediately to avoid hard landing on the floor

Strong message in the Sri Lanka Development Update 2019

Sri Lanka Development Update for 2019 was released by the World Bank last week. This document contains a review by the bank’s residential staff of the present state of the country’s economy and the risks it faces in the immediate future. Behind the diplomatic language it has used, there is are two strong messages it has delivered to the previous Mahinda Rajapaksa administration, the present Good Governance Government and any government that may come to power in the future. 

One is that the deteriorating economic performance which the country had started as from 2013 will continue without an appreciable recovery till 2021. The other is that the country’s declining labour force and labour productivity will have a negative effect on its growth potential in the next two to three decades. The gist of these two messages is that Sri Lanka should take immediate measures to arrest and reverse this trend if it is to realise its goal of becoming a rich country within a generation. 

 

Failure to maintain economic buoyancy after the end of the war 

The picture painted by the World Bank in its development update is summarised in graph 1. Immediately after the end of the war, there had been ‘significant buoyancy’ in economic activities in the country raising its average annual growth rate to a level above 8%. 

However, the economic strategy adopted by the country during that period as well as in the few years following had basically concentrated on establishing an economic system based on the domestic market for growth and prosperity. This was manifested by the low emphasis given to exports that declined as a ratio of both the Gross Domestic Product or GDP and the global exports. 

Since the domestic market placed an effective limitation on the expansion of industry, the country could not sustain this high growth beyond 2012. The period thereafter saw a drastic fall in the growth rate recording nearly a half of what had been attained previously.

 

Good Governance Government too has failed 

When the new Good Governance Government came to power in January 2015, the average growth rate amounted to 4.2%. The challenge before the new government was to recover the economy from that low growth and push it back to the previous high growth path. Yet, the outcome was dismal and it also had to live with the same low growth rate of 4.2% till 2017. The projection for the period from 2018 to 2021 by the World Bank has been even below the average growth rate in the previous period. It will amount on average to 3.5% per annum. This is a too low growth compared to the target envisioned in the Vision 2025 plan of the government. Thus, Sri Lanka is moving down a staircase placing its step on a lower stair at each successive move. This is the conclusion which an intelligent reader could make from the data which the World Bank has produced in its development update. 

When it is translated into policy, it calls on the Government to take measures, as a matter of urgency, to arrest and reverse the declining trend. If this is not done, the next move will be to step on the ground causing Sri Lanka economy to stagnate, on the one hand, and become a laggard among its peers, on the other. Surely, this cannot be the goal which Sri Lankans are planning to realise.  

The World Bank Economic Development Update 2019 pinpoints to the Sri Lanka Government that it should immediately take action to change the country’s production strategy. It cannot rely on the demographic dividend anymore to create wealth and prosperity. It should now seek to improve the quality of the work force so that the workers could embrace high technology and commence producing new products for export market. As I have argued in my previous articles, joining the global production sharing network and supplying components for high tech involving manufactured goods is a must for Sri Lanka today. If this is not done, it is unavoidable that the country moving down a staircase would make a hard landing on the floor

Shooting the messenger instead of the message

This is an objective and impartial analysis made by an outside body. Its aim is to impress upon those who rule the country that there is no time left for them to hang around. The sooner they get into action, the better for the economy. However, the normal tendency in Sri Lanka, as well as in many other countries, has been to consider critique with disdain. When the economy started stalling in 2013, I drew the attention of the Rajapaksa administration to the need for quick action. Instead of taking the message, it began to shoot the messenger calling my analysis ‘unprofessional and vindictive’.  

Politicians should learn to tolerate criticism

The Good Governance Government was no better. Its leaders not only ignored the warning, but also began to attack me personally after the economy had plunged to an unrecoverable depth. Similarly, the warning by the World Bank and my highlighting the same in this article will run the risk of being ignored, on the one hand, and causing the Government policymakers to transform themselves to an offensive mode, on the other. 

They must take cue from a former Minister of Finance – Dr. N.M. Perera – who was with a leftist orientation. Addressing the Central Bank staff in 1971 he had said that he would value the reports made by the bank ‘impartially and dispassionately without the colour of the political complexion of the party in power’. If the present government does not take this message in its true spirit, the unavoidable casualty will be the economy.

 

Effective population planning reducing the growth rate in population

Sri Lanka’s growth drivers in the past had been not the investment in physical capital but the increase in the labour force in numerical numbers. As such, the country which had an unemployment rate of 26% in 1977 was able to reduce it progressively through the deployment of its cheap labour in labour intensive industries, namely, the apparel industry. This helped Sri Lanka to diversify its exports, provide employment opportunities to a large number the unemployed and make a positive contribution to economic growth. This is known as ‘demographic dividend’ in economic parlance and Sri Lanka used it to the maximum in those high unemployment days. 

However, along with the open economy policy introduced to the country as from the end of 1977, Sri Lanka went for an effective population planning programme. Previously, the population in the country had been growing at more than 2% per annum. It not only imposed constraints on the country’s carrying capacity but also its ability to continue with welfare measures in which most of the public services were provided free of charge or at heavily subsidised rates. The population planning programme paid its dividend in about two decades by pushing the growth in population close to 1% per annum. In 2017, it is now even below 1%. 

 

Population pyramid getting converted to the Lotus Tower

The result was, as projected by demographic experts, to convert the traditional population pyramid to that of a ‘flower vase’ in which the middle was bulged. In 2015, it was like a Buddhist stupa or a pagoda, but by 2050, it is projected to take the shape of a cylindrical tower as given in figure 1. 

The main contributors to this development have been the decline in women’s fertility rate, while the mortality rate remaining unchanged. According to the World Bank data, in 1960, Sri Lanka had on average 5.5 births per woman. By 2016, it has fallen to 2 births per woman, almost equal to the rate prevailing in developed countries. At the same time, the mortality rate has remained at around 6 per 1,000 people in the country. With increased longevity of Sri Lankans, especially the females, the traditional population pyramid is expected to imitate the Lotus Tower which now adores Colombo’s skyline. This would not only reverse the demographic dividend, but also will compel Sri Lanka to change its resource allocation and economic policy strategies. 

 

Ominous increase in the dependency ratio

But this outcome has not been unexpected since it is the natural transition which a country following population planning would go through. In such a situation, economic policy strategy should be changed from labour intensive to technology intensive production methods. Sri Lanka will be compelled to do this, since the share of Sri Lanka’s working age population, according to the World Bank data, had peaked in 2005 and is on the decline right now. 

The corollary of this development has been the increase in the dependency ratio, that is, those below 15 years plus those above 69 years as a ratio of the working population. Given the present population projections, Sri Lanka’s population is expected to peak by 2035 worsening the dependency ratio thereafter. It will not only reduce the country’s potential growth but also create a new old age social security problem. Hence, making Sri Lanka’s population tech savvy is a must for recovering and sustaining the falling economic growth of the country. 

 

Using off-shoring to the maximum 

There are other global developments that have compelled Sri Lanka to go for this strategy. As mentioned earlier, after 1977, the country went for a cheap labour using production model that produced textiles and garments for labour expensive markets in developed countries. 

In order to exploit the cheap labour in developing countries, the developed countries too had adopted a production model in which factories were set up in the former group of countries. This production model was known as ‘off-shoring’ since the factories had been located in countries located off to the shores of the sponsoring countries. Three developments have caused those sponsoring countries to rethink of the off-shoring production model. 

 

Off-shoring has created Bazaar Effect

One is, as presented by German economist Hans-Werner Sinn, ‘the Bazaar Effect’ in manufacturing production which the developed countries had begun to undergo. After off-shoring became the mantra used by production units in those countries, they just became traders or bazaars in manufactured products earning only trading profits while losing manufacturing sector jobs. In the bazaar trading system, goods manufactured in off-shore factories would be labelled as products of the parent country and exported to other destinations. 

A good example is the Apple products in which there is a production tag saying that they had been designed in USA and assembled in China. The other two reasons have arisen due to the action taken by mother companies to address the hostility to Bazaar Effect by both the domestic policy makers and the domestic workers.

 

Desire to have production facilities in proximity to the markets 

Accordingly, through Artificial Intelligence or AI and robotic development, most of the labour intensive products could be manufactured in the countries where the markets are located. A case in point is the garment industry which was off-shored to the developing world because of the cost advantages. But technology had permitted the mother companies to produce the same garments in locations in the countries where the markets are within proximity. This production method is called ‘on-shoring’. 

At the same time, the need for delivering swiftly the customised products to customers back at home have compelled the major trading houses to look for factories located in nearby countries. This is known as ‘near-shoring’ of manufactured products. This is because a garment manufactured in Sri Lanka or Bangladesh would take at least 30 days for delivering to trading houses via sea routes. But the same garment manufactured in a nearby country under near shoring will take only three days for delivery via land. Hence, there is a growing demand for both on-shoring and near-shoring of garments by trading houses operating in developed country markets. 

 

Growing importance of on-shoring and off-shoring

McKinsey Global Institute in a recent report has identified the on-shoring and near-shoring garment production units serving both the European and North American markets. This is presented in the figure 2. Accordingly, Europe is served by on-shore industries located in the UK, Macedonia and Portugal that use robotic manufacturing methods. At the same time, it is served by near-shoring productions units in Turkey, Tunisia and Morocco. In the same way, the North American market is on-shored by factories in Mexico and the United States. That market is also supplied by near-shoring manufacturing outfits located in El Salvador, Guatemala and Haiti. According to McKinsey Global Institute, about 65% of the requirements in these markets would be supplied through on-shoring and near-shoring by 2025. This new global development will affect both Sri Lanka and Bangladesh which heavily depend on the apparel industry for earning foreign exchange and creating wealth.

 

Sri Lanka should move to tech-intensive production models 

Thus, the World Bank Economic Development Update 2019 pinpoints to the Sri Lanka Government that it should immediately take action to change the country’s production strategy. It cannot rely on the demographic dividend anymore to create wealth and prosperity. It should now seek to improve the quality of the work force so that the workers could embrace high technology and commence producing new products for export market. As I have argued in my previous articles, joining the global production sharing network and supplying components for high tech involving manufactured goods is a must for Sri Lanka today.

If this is not done, it is unavoidable that the country moving down a staircase would make a hard landing on the floor. 

(W.A. Wijewardena, a former Deputy Governor of the Central Bank of Sri Lanka, can be reached at [email protected].)