The Sunday Times Economic Analysis

The controversy regarding the growth rate for 2006 has perhaps distracted readers away from significant changes that the economy has undergone in the last few decades. Last year's economic performance reinforced those structural changes. There are various interpretations of the structural transformation that has occurred that requires to be clarified for a proper understanding of the country's economic development. This is especially so with respect to the declining contribution of agriculture in the total of goods and services produced in the country (GDP) that is incorrectly interpreted.

The contribution of agriculture to GDP has declined to around 16 per cent in the last few years. Together with fisheries, forestry and livestock the contribution is around 18 to 19 per cent. There has been a secular decline in agriculture's contribution to GDP especially since 1978. Agriculture in GDP declined to 23.3 per cent by 1990, 19.7 per cent by 2000 and to only 18 per cent by 2006. In contrast there has been a sharp increase in the contribution of the services sector from 40.6 per cent in 1977 to about 55 per cent.

These changes are viewed differently by various shades of public opinion and political views. Some argue that the decline in agriculture's contribution should be arrested and even contend that there should be a proper balance among the sectors, with agriculture, manufacturing and services contributing equally. This "balanced" approach in fact goes against economic theory as well as the experiences of economic development in all countries in the world. Those advocating a high proportion of GDP for agriculture should indeed educate themselves and should not be misleading the younger generation in particular. The process of economic development is one where the contribution of agriculture declines in relative importance as other sectors grow. This has happened in all countries of the world. The best example is the United States where despite its huge production of agricultural commodities and large exports of agricultural produce, agriculture's contribution to national income is only about 3 per cent.

It is manufacturing and services that contribute the overwhelming 97 per cent of GDP. The diminishing relative importance of agriculture is a healthy development. In fact quite often a country's development is assessed by the proportion of agriculture in a country's GDP. The higher agriculture's contribution is to GDP, the lower it is ranked in the totem of economic development. Nonetheless the manner in which Sri Lanka has reached the diminishing significance of agriculture is not altogether desirable. On the one hand, manufacturing and services sectors have expanded and made a significant contribution to the changes in the different sector contribution. This is a healthy development. On the other hand, there has been a relatively stagnant agriculture that has also contributed to its declining significance. This change is indeed an unhealthy one as the declining relative importance of agriculture should be achieved with an increasing output of agriculture outpaced by a much higher growth in other sectors. In the last decade the growth in agriculture has been a modest 1 per cent. Other sectors have grown very much more, especially the services sector.

Even in 2006 when there was a fair growth in agriculture its contribution to growth was modest. This was partly owing to the relatively lower contribution to the economy that has been noted as well as agriculture's achievement being modest in comparison with the performance of other sectors. The agriculture sector grew by 4.7 per cent contributing 11.1 per cent to the overall growth while industry grew at a faster rate of 7.2 per cent, thereby contributing more than twice to economic growth than that of agriculture at 27 per cent. The contribution from the services sector was the highest at 62.6 per cent, as the sector grew by 8.3 per cent during the year and its share of GDP was much higher than either agriculture or industry. The main contributor to agricultural growth was the record paddy output of 3.3 million metric tons.

The undeniable fact is that the economic reforms of 1977 had a significant impact on the structure of the economy and transformed the Sri Lankan economy from a largely agriculture-based import-export economy to a far more diversified one. Export led manufacturing gained in importance progressively after the reforms. The share of manufacturing in GDP that had declined to 14 per cent by 1977, increased sharply to 20 per cent by 1990, 23 per cent by 1997, and to about 28 per cent currently.

Before 1977 industrial output consisted of tree crop processing and a few industrial products like cement, chemicals, glass, a large number of small industries producing a wide range of consumer items for the protected domestic market and cottage industries. In the post 1977 period of trade liberalisation and encouragement of foreign investment, there was a significant expansion and diversification of the industrial sector. Factory industry replaced export crop processing in importance. Small and cottage industry declined. Factory industry now contributes most of the industrial output with tree crop processing contributing less than 10 per cent and small industry less than 5 per cent of total industrial output. Unlike in the pre-1978 period private industry is dominant. Factory industry itself has shown considerable diversification despite ready-made garments holding a dominant position by contributing over 50 per cent of industrial output.

These structural changes in the economy are reflected in the country's trade pattern. Agricultural exports dominated the export structure from the beginning of the plantation economy till the 1980s. A significant diversification of exports occurred in the 1980s, and by 1989 agricultural exports had declined to about 35 per cent of exports. Now it is less than 20 per cent. In fact agricultural and industrial exports had exchanged their positions of importance.

Though garments dominate industrial exports, a diversified export portfolio consisting of rubber based products, leather and footwear, ceramics and machinery and equipment have been showing an increasing trend. The diversification of industrial exports over this period led to garments contributing less than 50 per cent of total exports for the first time in 2004. Other industrial exports are a wide range of products. It should be also mentioned that there has been a diversification and increase in agricultural exports as well. However these face a severe price competition from neighbouring India and Pakistan where costs of production are much less.

These changes in the economy are in the right direction and should not be scoffed at. In fact the magnitude and rapidity of these changes are inadequate and there are some qualitative changes within the overall direction that could be improved. Besides, in as far as agriculture's contribution to GDP is concerned, though its declining importance is healthy, the fact that agricultural growth has been a mere 1 per cent in the last decade is a matter of concern. There is still a significant contribution that agriculture could play in the country's development through increased productivity in crops, diversification to higher valued crops and the processing of agricultural
commodities.

Changing face of the economy