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Sustaining economic growth difficult but possible
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Can the economic growth momentum of the post-war years be maintained? Paradoxically, it is the manner in which the high growth was achieved that is detrimental to longer term economic growth. Much of the growth was due to reconstruction, infrastructure development and post-war resuscitation of the economy. These activities do not have a self-sustaining momentum.
The pattern and productivity of investment, the foreign debt-driven growth, the high debt-servicing costs and weak fiscal management are detrimental to long run economic growth. It is therefore imperative that the weaknesses in the current economic growth strategy are recognised and corrected to sustain the growth momentum. Different priorities in investment, prudent public expenditure, and higher foreign direct investment together with economic, educational and administrative reforms are needed for long-term economic development.
Post-war growth
The post-war growth momentum cannot be maintained without a change in strategy. The initial post-war spurt in economic growth was owing to the resuscitation of the paralysed sectors such as agriculture, fishing and internal trade and new vitality in others. Investment in reconstruction contributed much to growth compared to the contribution from increased productivity. However, manufactures grew slowly and imports were nearly twice exports.
Large trade and fiscal deficits and high foreign and domestic debt servicing costs that have been incurred are burdensome and destabilising. Macroeconomic weaknesses brought about by the investment strategy, depending more on increasing investment than improving productivity, has eroded the capacity of the economy to sustain its growth momentum.
Infrastructure investment
Development of infrastructure gained considerable momentum after the war and contributed significantly to high growth in the post-war period. While development of infrastructure is vital for economic development, there are two deficiencies in the model of infrastructure investment. First, infrastructure investment has a long gestation period and the massive costs of such investment have not been from domestic sources. Moreover, it is concentrated in the non-tradable sectors that do not increase exportable goods nor produce efficient import substituting goods. Consequently such foreign-funded investments do not directly support repayment of debt. As a result, the foreign borrowing to fund such investment has resulted in a large foreign debt, whose servicing costs could be destabilising.
The returns to infrastructure investment are in any event long term. While some infrastructure investment in highways, improvement of roads, new bridges, fisheries harbours and similar projects would contribute to economic growth in the fullness of time, they are an economic burden at present. Furthermore, some large infrastructure projects, instead of generating output and contributing to growth, are white elephants that are absorbing money for maintenance.
Macroeconomic fundamentals
The growth strategy adopted has eroded fundamental macroeconomic stability and led to large fiscal and trade deficits, huge public debt servicing costs and large foreign debt-servicing costs that could seriously impair economic growth. Fiscal deficits have been over 6 per cent of GDP. In fact much larger if the contingent liabilities of the government to state banks and the proxy borrowing of large amounts for government expenditure are included in the public debt figure. The entire annual revenue being inadequate to meet debt-serving costs is a serious constraint on investment and developmental expenditure.
In the last three years, trade deficits have been US$ 9.7 billion (2011), US$ 9.4 billion (2012), and US$ 7.6 billion (2013). The consequent weaknesses in the external finances have led to further borrowing at commercial rates. Consequently a high proportion of export earnings are expended for foreign debt servicing. These macroeconomic weaknesses will impinge on the capacity of the economy to grow.
Need for new policy directions
The recognition of these weaknesses and corrective actions are imperative. The vast investment in infrastructure development projects must be reduced and investments should be to priority areas where the gestation period is short and would increase tradable goods and services. At the same time there is a need to enhance investment in social infrastructure to ensure long-term growth and social welfare that impact on economic growth.
Improvements in social infrastructure, health and education, are fundamental prerequisites for long-term economic development. Improvements in general, science and technical education and educational reforms that would improve the content and quality of education and support economic productivity are vital to sustain economic growth. Increased expenditure on public health facilities to improve the nation’s health, which is both a means and an end of economic development, is also needed.
Much higher foreign direct investment (FDI) is vital for Sri Lanka’s sustained high economic growth. The slow and inadequate foreign investment inflows into the country are a constraint on economic development. In 2012 FDI increased somewhat to US$ 815 million and it is estimated that FDI grew to nearly US$ 1 billion in 2013. This is still low compared to what countries like Vietnam or India have attracted. Besides, much of recent FDI has been for buying land and building of large hotels and very little in export industry.
The reduction of the public debt and its servicing cost is a prerequisite for economic stabilisation and growth. Large fiscal deficits harm the economy in many ways. They lead to borrowing and in turn to huge debt servicing costs. The massive public debt and crippling debt servicing costs distort public expenditure priorities and hamper economic development; especially as public expenditure has high unproductive and wasteful expenditure.
Summing up
The recent economic development strategy has weakened macroeconomic fundamentals and consequently jeopardised long-term growth. The high rates of post-war economic growth cannot be maintained without economic reforms and policy changes that increase productivity. Fiscal consolidation, improving the external finances, readjusting prioritisation of public expenditure, attracting higher foreign direct investment, economic reforms and increased investments in social infrastructure are vital to sustain the economic growth momentum.
It is intriguing that a recent IMF study using a sophisticated econometric model has come to a similar conclusion that the current economic growth is destabilising and would decelerate growth in the future.