Accelerating inclusive growth: The role of the external sector

Research issue

Sri Lanka’s growth cannot be examined in isolation. This is because its economy is intricately interwoven to its neighbours and other countries through commercial, political and cultural links.

The sustainability of any growth strategy adopted by the country will depend on the stability of different partnerships and the ability of the country to be resilient to adverse shocks. Given this, any strategy that looks at improving equitable growth will need to take stock of the international environment within which the Sri Lankan economy is functioning.

Sri Lanka needs to look at developing stronger linkages with healthier economies of Asia and explore new trading opportunities, and move away from the excessive dependence on the US and EU

As developed economies – which remain the primary export markets for most developing – struggle to recover from the global financial crisis, competition amongst developing country exporters will heighten. Many countries are opting for preferential market access via trading arrangements of one sort or another.

Any trade policy reform – be it unilateral, bilateral/regional, or multilateral – will have eventual ‘beneficiaries’ and ‘losers’. Often, while adjustment costs for the economy overall are borne in the short term, it could well be that long term costs prevail for particular industries or sectors.

The distributional impacts of trade policy cannot be ignored, particularly when Sri Lanka is attempting to achieve not only rapid growth, but a growth process that is both equitable and inclusive to meet its long term post-conflict development objectives

In this context, a fresh look at Sri Lanka’s recent export performance and future prospects is warranted, with a special focus on distributional impacts.

Key messages

Merchandise goods exports saw a strong recovery in 2010 following the downturn in 2009, led by textiles and garments (42 per cent of industrial exports) and tea (16 per cent of agriculture exports), complemented by a rapid growth in services exports, led by transportation (47 per cent of services exports) and IT (11 per cent of services exports).

Sri Lanka also benefited from earnings from migrant worker remittances – unlike other inflows, worker remittances remained relatively healthy during the downturn of 2009 posting a strong growth of 23.6 per cent.

However, despite the absolute increase in export earnings, it is of some concern that Sri Lanka's export earnings as a percentage of GDP – a measure of how much export-led an economy is – has been falling continuously in more recent years – from 30 per cent in 2000 to 16.7 per cent in 2010.

Indeed, Sri Lanka’s export penetration – i.e., its share of global merchandise exports – has mirrored this decline, falling from 0.09 per cent in 2000 to 0.05 per cent in 2008.1 Also disturbing is the undiversified nature of both its exports and export markets – the US and the EU continue to be the largest importers of Sri Lankan products, attracting 56 per cent of the country’s total exports in 2010.

For Sri Lanka, greater trade openness has had many positive impacts, including the generation of significant employment and income earning opportunities, particularly for rural females – women account for over 70 per cent of the labour force in the export garments sector while 73 per cent of outgoing migrant workers in Sri Lanka is estimated to be from outside the Western Province.2

However, outcomes in other export sectors are less clear. Whilst tea exports have historically provided much needed foreign exchange earnings, the estate sector population has remained mired in poor socioeconomic conditions.

Additionally, those sectors most open to trade and investment opportunities – centred in urbanised settings – have also led to widening output gaps and related poverty indicators across sectors and provinces of the country.

Besides the industrial sector, the services sector has also been a significant contributor to export earnings and economic growth in Sri Lanka in the recent past. Unlike manufacturing, however, the services sector tends to generate employment for higher skilled workers.

As Sri Lanka turns increasingly to promote services-oriented export activities – including efforts to develop the country as a hub for select services – the employment opportunities that will be generated will most likely require a higher skills profile that could have broader distributional and equity issues in the country.

Way forward

It is clear that 2011 is likely to see a lethargic recovery in both the US and EU markets, which is something Sri Lankan exporters need to be vigilant of. Sri Lanka needs to look at developing stronger linkages with healthier economies of Asia and explore new trading opportunities, and move away from the excessive dependence on the US and EU.

To this end, it is notable that India regained its position in 2010 as the third largest single market for Sri Lankan products, a position it held last in 2007. Stronger links with the other Asian giant, China, would also help.

The policy challenges to provide a conducive environment to promote an export-push are many. While the ongoing infrastructure development in the country will certainly ease some of the constraints, more needs to be done to provide a supportive regulatory environment, be it in developing a dynamic SME sector or attracting export and knowledge-enhancing inflows of FDI.

Another key area of concern with regard to a supportive macroeconomic environment for export growth is the movement of a country’s real exchange rate. The Sri Lankan rupee has been experiencing a real appreciation over time that adversely impacts the competitiveness of its exports in international markets.  The role of complementary polices – designed to help the poor participate in the positive opportunities that emerge while protecting them from harmful consequences – cannot be ignored in addressing the distributional and equity issues of an export-led growth strategy.

This is all the more important in ensuring that higher foreign exchange earnings hold the potential to not only support growth, but also to meet the Government’s efforts to ensure that the benefits of that growth are equitably distributed.

Footnotes:

1 IMF, Direction of Trade Statistics 2009.

2 Sri Lanka Bureau of Foreign Employment, Annual Statistical Report 2009.