Case for Sri Lanka on Services Sector

The Central Bank’s Deputy Governor W.A. Wijewardene examines the current controversy surrounding the services sector as a viable and sustainable wealth creator for Sri Lanka and makes a case for a greater focus in this sector in the country. This was in the course of the Professor Sirisena Thilakaratna memorial lecture which he presented recently at the Central Bank auditorium at Rajagiriya.

Excerpts:
The services sector is often quoted as a sector that does not or cannot create real wealth. This view is sometimes expressed by even mainstream economists. According to them, real wealth in a society is created only by visible products that are generated by agriculture or industry. On the contrary, the services sector which produces invisibles does not lead to any improvement of wealth on a long-term basis. Hence, any preponderant growth in the services sector over the real-good producing sectors is considered as a risk.

The widely held view that Sri Lanka is an agricultural economy and it should continue to be so in the future as well has entailed certain limitations on its future growth.

Throughout its history, Sri Lanka has been a beneficiary of being an active partner in global trade. In addition to be located on a very convenient naval route, conducive policies adopted by successive rulers have been a booster to international trade, and through it, to wealth creation.

The reliance on services, especially commercial services, for wealth creation is not a new policy paradigm for Sri Lanka.

Around the time Sri Lanka gained independence from British rule, the country’s GDP was distributed in the proportion of 46 percent for agriculture, 20 percent for industry and the balance 34 percent for services. The high share of both agriculture and industry amounting to about a two-thirds of the GDP indicated the prevalence of a limit for their continued growth devoid of a vibrant and efficient services sector.

This anomaly was to be gradually, and in a slow pace, corrected in the subsequent five decades. In 1960, a slight improvement in the respective shares was observed with agriculture falling to 38 percent and services rising to 45 percent. The period since then recorded a virtual stagnation of services till early 1980s when the country moved to an open economy regime.

During the period from 1980 – 2005, the agriculture sector further declined in relative terms from around 28 percent to 17 percent, while the industry remained unchanged at around 25 – 26 percent. But the services sector increased its share from 43 percent in 1980 to 56 percent in 2005. In the recent past, services has been the main and the significant contributor to economic growth in Sri Lanka, pushing industry and agriculture to the second and third places, respectively. It is this phenomenal growth in the share and the contribution of services which has caused concerns for and attracted criticism by some quarters.

Statistics show that the current level of services in Sri Lanka is more or less equivalent to the status which the services enjoyed in developed countries in 1960s. While Sri Lanka is far ahead of the two giant growth machines in the region, -- China and India, it would not be too long for these two countries to overtake it, given their current services promoting policies.

The services sector has also been growing in importance in all the countries during the past five decades or so. Some countries have now attained the optimal level of services above 70 percent.

This indicates that the countries which are still below that level have an enormous potential for further growth. But the question posed has been whether such growth would be sustainable or not in the long run. In other words, whether it could continue to create wealth and improve the standard of living of the people. It can be safely concluded that a share of about 65 to 70 percent in the services sector would provide a country with immense prospects for wealth creation, provided it gains competitive advantage in the production of such services. In this context, the future growth prospects available to China are enormous, since its services sector still accounts for only 35 percent of its GDP. Both India and Sri Lanka too stand to gain on account of the leeway available for them to push the services sector’s contribution to above 65 percent. Hence, it is important that they should exploit this growth potential without further delay.

Potential for services in Sri Lanka
The widely held view that Sri Lanka is an agricultural economy and it should continue to be so in the future as well has entailed certain limitations on its future growth. This belief would have been nurtured by the historical experience of high prosperity which the country attained through agriculture, specifically through subsistence paddy farming, in both Anuradhapura and Polonnaruwa eras. In these periods, when the country was subject to frequent foreign invasions, it would not have been unusual to regard food security as the number one priority of the nation.

Hence, a larger share of growth, output and employment was occupied by agriculture. But today, these issues are not of grave concern to a nation open to the rest of the world. This is because international markets have developed both intensively and extensively to cater to every possible demand from consumers. Hence, countries in the present era could easily replenish food shortages, provided they have the required purchasing power. Agriculture faces a serious manpower shortage too, because it is not the most preferred occupation by many.

This is because, Sri Lanka’s universal free educational system, an enviable pride among other developing nations, has been instrumental in creating a generation of educated youth with an urban ideology, based on a marked preference for white-collar jobs. Even in the predominantly agricultural areas, the trend has been the same. Consequently, it has become a nearly impossible task to keep rural youth occupied in agricultural activities. This has made it necessary for opening new employment avenues for such youth. An additional factor has been the natural limitation for growth of agriculture due both to the slow growth in demand for agricultural products and the supply constraints of land for further extensive cultivation practices.

Sri Lanka’s agriculture sector has made its utmost contribution to create wealth and employment in the past. Its current ability to do so has been a matter for debate. With employment in agriculture being seasonal and the concentration of a large farm-based work-force on a limited extent of cultivable land, underemployment has been the natural corollary in Sri Lanka.

The new evidence shows that the under-employment in agriculture in Sri Lanka is not only the highest but also on the increase.
Agriculture has a further limitation in the form of low productivity and low contribution to GDP. Since about one third of the labour force is engaged in agriculture, its total output is distributed among a large number of workers.

If agriculture has its limited capacity for an accelerated growth, why not concentrate on industry? This may be a pertinent issue to be addressed at this stage. Certainly, unlike agriculture, which is faced with the limitation of land, industry does not have any capacity or demand limitations.

The non-availability of raw materials or essential inputs or even the domestic demand for the output does no longer inhibit industrial growth. With globalization of trade and services and advancements in information and communication technology (ICT), the previous bottlenecks for industrial growth have been efficiently sorted out. In today’s context, industrial outputs do not belong to a particular nation or country. They are jointly held products to which many nations or countries would have contributed. Countries with cost-advantages, driven by technology and innovation, have been able to attain specialization in sub-components of given final industrial products which are assembled in global factories.

Sri Lanka which is devoid of a sufficient natural resource base would find it difficult to enhance growth through industry or agriculture alone. The country’s available land is limited and its population density at 293 persons per square kilometer is one of the highest. In comparison, Canada has a density of 3, USA 31, New Zealand 14, Australia 3 and Russia 9. While the latter group of countries could conveniently move into extensive farming, Sri Lanka’s choice is limited only to improved productivity through intensive cultivation. That again is through innovation which comes from services.

The second factor that would drive Sri Lanka to the services sector is the ever rising globalization of services. In the past, services which, by nature, cannot be stored, were non-tradable. Hence, there was no any prospect of selling services beyond the borders of a country limiting its clientele to its own citizens.

If any foreigner desired to avail himself of any services, he should necessarily have traveled to the country of services at great costs in terms of both time and money. This is why cross-border services were limited only to areas where foreigners could have them relatively at a low transaction cost. In this context, the services which played a prominent role in the global arena were shipping and insurance services where the service provider visited the buyer and travel, education and health services where the buyer visited the service provider. In all these areas, Sri Lanka had a head start over other competitive countries.

Sri Lanka’s university system at the time of gaining independence was one of the best in the world. It also had a very reliable and high quality curative health system. For shipping services, it had the best comparative advantage by being located on a very important naval route. Its ports in Colombo and Trincomalee had the best cost-advantage.

Its highly literate work-force with professional qualifications from the UK and other advanced countries could have provided the best insurance and banking services to the rest of the world. But, due to the inward orientation of the policies adopted since independence, these comparative advantages got shifted to other countries such as Singapore, Hong Kong and Australia. For Sri Lanka, it is, therefore, a story of missed opportunities.

It is too late now to lament over the failed past. What the country should do is to plan for the future, so that Sri Lanka could conveniently get itself integrated to the globalised services industry.

India’s ascent to a formidable global ICT power has been mainly driven by economic reforms, establishment of a free market democracy, perseverance of some unbeatable private entrepreneurs and above all, continuous human capital development in engineering and electronic fields.

The last development came from the high educational standards maintained by a web of reputed state owned Indian Institutes of Technology (IITs) and permission given to the private sector to set up higher learning institutes.

This is definitely an eye opener for Sri Lanka. Even in the midst of growing evidence from India and elsewhere that privately owned institutes of higher learning could make a significant contribution to the globalization of education and training, Sri Lanka still keeps education as a closely-guarded relic in the public sector. As a result, its capacity to meet the demand for higher education is woefully low with one place being offered to satisfy about 16 aspirants. This has led aspiring youth to seek higher education in other countries at a high personal investment cost. Since every investment should yield commensurate returns, it also has compelled them to seek employment elsewhere. Whatever the intention, the closely protected public university education system has become a waste of scarce public resources, since only a fraction of the total registered students is reported to be in attendance in classes. Hence, to gain reputation as a global centre of learning, it is necessary that Sri Lanka’s university education system should undergo a complete overhaul and reform.

A further benefit which Sri Lanka could gain by promoting a global market based services sector is the possibility of narrowing the current account deficit of the balance of payments through enhanced service income. Historically, Sri Lanka is having an ever ballooning deficit in the merchandise account. With high international oil prices and rising intermediate and investment goods imports, this deficit has risen to a very high and unsustainable level of about 13 percent of GDP by 2006. Countries with such large trade deficits should attempt to generate an equivalent surplus in the services account so as to finance the same. However, the surplus being generated by Sri Lanka in its services account has not been sufficient to fully off-set the trade deficit. As a result, Sri Lanka normally runs a current account deficit of 5-6 percent of GDP which has to be financed through capital flows. This level of a current account deficit, occurring year after year, is not sustainable. Given this scenario, the enhancement of the income from services by promoting the services sector would definitely help the country to have a stable balance of payments position.

What should the country do to attain the goal of having a vibrant and efficient services sector? First of all, it should invest heavily in infrastructure so as to facilitate the production of services. In this connection, the proposed international airport and the port in Hambantota and the attendant road-network would make a significant contribution to facilitate the promotion of global services. But the country should not stop there. As a top-most priority, the road network should be improved to be on par with global standards.

Roads would create access to markets and reduce transaction costs. Since the services, like the visibles should be produced at the cheapest costs to attract global customers, the maintenance of efficiency at all levels of the economy is a must. For this purpose, the country needs to be wired electronically covered by a reliable road network.

The conclusion to be drawn from the discussion so far is that Sri Lanka has missed opportunities in the past, but it need not continue to suffer in the future. It is still not too late to re-orient the economy towards the establishment of a vibrant services sector catering to the needs of the globalised industry, trade and commerce. The country’s highly literate and easily trainable work-force, investments in ICT infrastructure and conducive economic reforms will pave the way for its entry to the newly emerging globalised services industry. If Sri Lanka does not acquire its position in this newly emerging global trend, as it did during the Anuradhapura and Polonnaruwa periods, it cannot be avoided to be relegated to yet another episode of missed opportunities.