The resilience of the Sri Lankan economy - Fact or fiction?

By the Economist

The Sri Lankan economy it is often said is resilient. An economic growth of above 5 percent is advanced as the evidence for the resilience. The question is being frequently asked as to how the economy performs as well as it does, in the midst of street bombings, a costly war, high inflation, political uncertainly, rising import prices of petroleum and other imports and a chaotic political scenario. The answer that is often given is that the economy is resilient. That is an answer that begs the question. The question is how is it that the economy is so resilient? Is the economy in fact resilient? Is the notion that the economy is resilient a myth? Is this idea of resilience over played? These are certainly questions to ponder over.

The basis for the idea that the economy is resilient comes from the fact that the economy has performed at above a growth rate of 5 percent in recent years. In fact, last year it is claimed that the economy grew by as much as 7 percent. It is also the view that despite the continuing adverse impacts on the economy, that the economy would grow by 6 percent this year. Therefore it is contended that the Sri Lankan economy is resilient.

The first question to ask is whether these growth figures justify the appellation of resilience. There are three issues here. First, are the statistics reliable? Second, what is the quality of the measured growth? Third, are there hidden explanations for the growth?

The answer to the first question is a qualified one as we do not have an alternate estimate of national accounts. This column has put forward the idea before, that there are a number of areas in the national accounts that are unreliable. In this context it is not difficult to massage the statistics.

An example of this is that, while in the case of paddy, tea and coconut production there is a systematic manner of estimation, there is a lack of reliable methods for the collection of production statistics for the other crops. This would not matter much if these were very insignificant amounts. In fact this "other" agricultural produce accounts for as much as about 50 percent of agricultural output. For instance, in 2006, these other agricultural products accounted for 47 percent of agricultural output and 8 percent of GDP. This was higher than the combined value for paddy, tea, rubber and coconut. We are not implying that the quantity and value of production of these is inaccurate, for we have no statistics to make such an argument. What we are saying is that these statistical inadequacies provide avenues for manipulation.

The second issue is the quality of growth. The national accounts include the value of all goods and services that have a monetary value. In the case of certain services, the value is assumed to be the cost or the wages. Therefore, increased expenditure on defence and employment of persons to the public services increase the national income by the amount of the additional costs incurred by the government. This affects the growth in the economy quite significantly as the increase in defence expenditure and the employment of graduates and others into the public services have bloated the national income. Stated explicitly, several contributions to growth are qualitatively flawed.It is not too difficult for a government to generate short to medium term growth by incurring large fiscal deficits.

Such growth cannot be sustained and would boomerang sooner or later, as it fuels inflation, an appreciation of the exchange rate and makes the country uncompetitive. So in the long run the country has less growth. In Sri Lanka's case, it is apparent that growth is not based on increasing competitiveness. If that were so, we should have greater export growth. The resilience of the economy can be compared to the circumstances of a man falling from the 20th floor saying he is enjoying the breeze!

The third issue is whether there are hidden issues in the growth scenario. The increase in the public debt, the foreign debt and the fiscal deficit provide a clue to this. It is not too difficult to grow on the basis of money spent that would never be productive. The government is able to generate a high growth owing to its expenditure exceeding its revenue, by borrowing money both domestically and from abroad. Again one has to be cautious by qualifying this assessment. We are not saying that all the expenditure incurred by the government or all the monies borrowed by it are unproductive. No. That is not so. But given the nature of government expenditure, the vast expenditure on the war, on salaries and pensions and debt servicing, we cannot help but think that there is a good measure of such fictitious growth. The problem is compounded by the fact that foreign debt has to be paid through an export surplus and therefore the debt financed expenditures must generate a growth in tradable goods. The expenditure items that have expanded such as imports for war raise the import side of the trade balance while making exports less competitive.

A good part of the economic resilience is due to the fact that a large measure of the economy is in private hands and to a large extent market forces determine investment and economic activity. Both due to the motivation of profit, as well as due to the instinct for survival, private individuals and business enterprises are finding ways and means of survival and profit making. Therefore despite hostile environmental factors, investment and economic activity continues to flourish. This means that these ventures have factored in the risks and uncertainties of the business environment and continue to operate at the maximum possible levels of activity. Importantly, private sector profitability has remained low and incentives weak since there has effectively been no reform of the incentive structure over the last several years. In the meantime, public policies such as forcing the private sector to pay higher wages unrelated to productivity could make our traditional exports less competitive with no compensating increase in the incentives for non-traditional exports.

There are also certain benefits of the adverse developments though they may not compensate fully for the losses incurred. While we talk about external shocks there is a lack of appreciation that these very shocks have brought benefits to the economy. The oil price hike is responsible for better prices for natural rubber, employment opportunities in the Middle East, increase in tea prices and an increase in non-traditional exports. The large amounts of remittances are an important factor in keeping the economy afloat. These remittances originate from many sources, though the limelight is on Middle East remittances of house maids. In fact a substantial amount of remittances are from other regions and from professionals as well. These inflows of capital are an important source of income support and investment of individuals and balance of payments support for the country. Similarly, the large inflows of capital for Tsunami relief were important in keeping the economy afloat in 2004 and 2005. Therefore these exogenous factors are also part of the explanation for the resilience of the economy.

The repetitive argument of resilience is a dangerous one. It in fact misses the point about the losses the economy has incurred and neglects the issue of why the economic growth in the country has been inadequate to raise living standards, increase employment opportunities and reduce poverty. The focus should be not on the so called resilience of the economy but the inability to grow adequately. Taking comfort in the present context of poor quality growth is misplaced. A country interested in its development would rather focus on the growth that has been lost, by especially, the war and the current political situation. In fact the Sri Lankan economy is performing well below its potential. The much better performance of so many other Asian economies is what has to be highlighted.