Manufacturing products for exports contribute to growth

By Lloyd F Yapa

Manufactured Sri Lankan exports (that is excluding apparel, cut and polished diamonds and gems and jewellery) had achieved a share of only 22% ($ 2.255 billion) of total exports ($ 10.3 billion) or 3.7% of GDP in 2012, (in which year total exports had declined to 17% of GDP from a high of 33% of GDP in 2004. The highest share reached was 24-25% of total exports in 2005 and in 2007.

Manufactured exports are an amalgam of some 14 products none of which had achieved a share of 10% of total exports. The lead product among them was rubber products which had a share of 8.4% of exports in 2012. This was followed by petroleum products (4.5%), food beverages and tobacco (3.5%) and electrical and electronic products (3.0%), making a total of nearly 20%. The size of the other manufactured exports could be imagined. (The share of high tech products was only 1.0% of manufactured exports).

In contrast, Malaysia which had achieved independence a couple of years after Sri Lanka (SL), exports high tech products such as semi conductors, motor vehicles, pharmaceuticals, medical technology besides light items, petroleum and liquefied gas, worth $239.8 billion (2012 estimate). The size of the industrial sector was 41% of GDP of $ 307 billion in 2012 (estimate).

The share of high tech products was 43% of manufactured exports.

In Singapore the share of manufactured exports (including construction) in 2010 was 27.0% of GDP; the lead products among manufactured products were high tech electronics and biomedical products. Total trade including re-exports amounted to US$ 662 billion in 2010, up by 21% over 2009; re-exports was 48% of total trade

Reasons for lagging behind

There are two major reasons for SL lagging behind other East Asian countries where manufacture for export are concerned. They are the failure to attract investments and improve national competitiveness of which productivity and innovation for differentiation of products and services are essential elements.

Significant investments especially foreign direct investment (FDI) which are necessary, as our national savings (24% of GDP in 2012) are inadequate to meet the estimated 35% or so of GDP of investment necessary to achieve a sustained economic growth rate of 8%. FDI could also provide the technology and skills that are scarce in Sri Lanka apart from world market access for goods and services. Investments could not be attracted because we have failed to develop the enabling environment sought by investors.

The writer remembers a Japanese Trade and Investment Mission which came to Sri Lanka on the invitation of the EDB in July 1983 and were discussing the subject at the BMICH when riots broke out in the streets of Colombo and other parts of the country. The Japanese stopped the discussions forthwith and left the country.

In 2012, Sri Lanka attracted FDI of US $ 776 million, while for Singapore it was a massive inflow of $ 57 billion and Malaysia did well with a large inflow of $ 10 billion (World Investment Report 2013, UNCTAD). This was the pattern in most years.

Where competitiveness is concerned, the main element is the ability to compete especially with the rest of the world.

Tariff protection has to be reduced significantly (to pressurise firms to increase productivity and innovate to earn higher returns by satisfying customer needs).

In the 2014 Budget we seem to have opted mainly for a continuation of import substitution. Import substitution tends to push up domestic prices and lower the export competitiveness of our goods and services due to the tariffs and various other levies at the point of import.

Import substitution also favours a small group of producers and not the large number of consumers.

There is now talk of removing certain items from the negative list of the Indo-Sri Lanka Free Trade Agreement. This will reduce tariff protection and improve competition.

The budget also proposes that SL should expand exports to destinations such as China, Japan and Brazil (other than the hitherto favourite markets in the West).

However, there are several issues to be settled, i.e. there is virtually no substitute for national competitiveness to expand exports.

Therefore, we have to work at it continuously as circumstances change. We have to make sure that investments create the capacity to export the goods especially by large foreign investors. The local enterprises concerned who are mostly SMEs, (who may protest; but it is the advantages accruing to nation that are important, have to be assisted by maintaining some degree of protection and to side-step these FDI by finding niche markets that these large investors do not compete in.

However, it would be unfair to say that the government has not made any effort to improve competitiveness of which productivity is an element. It has made a commendable effort, where previous governments dilly dallied, to improve physical infrastructure consisting of expressways, ports and airports, (though there are allegations that in some of these programs costs have increased steeply and quality has dropped due to omissions and commissions).

Now we see in Budget 2014 that these programs to develop rural infrastructure are to be continued. We see proposals in the Budget to develop tertiary level and technical education to develop skills and technology that could help to develop innovation to differentiate goods and services for export to earn premium and high export prices.

Productivity and innovation will certainly improve in these areas if adequate allocations are made and implemented successfully.

An effort is also being made in this Budget to improve revenue and prune expenditure to contain the budget deficit to realise macroeconomic stability (in addition to the policy of maintaining a flexible exchange rate and low interest rates). This could help to reduce costs.

There is also a proposal to amalgamate banks and financial institutions perhaps to improve their productivity and another to solve the problem of non-performing loans of state banks.

All in all it is gladdening to see programs to improve productivity and competitiveness being introduced; one must add that significant productivity improvement in other neglected production areas such as labour (including the staff in the public service) and land has also to be realised and simplification of cumbersome procedures and documentation, along with reduction of tariff protection to improve competition have to be undertaken, to achieve full national competitiveness.

In other words a comprehensive set of proposals is required to achieve national competitiveness. See www.slea.lk of the Sri Lanka Economic Association for a complete set of proposals.

Why manufacture?

First, manufacturing by large reputed local and foreign firms could provide well paid productive jobs and absorb excess employment in agriculture (about 31% of total employment), in the public service (about 1.2 million and counting), the men and women (over1.0 million) slaving away in the Middle East and other foreign lands, (while their children are neglected and abused at home) and also reduce the brain drain of skilled personnel which is supposed to be 10,000 per year.

Those seeking employment in foreign lands especially women and their families will lead happier lives in the country since manufacturers could provide them with alternate gainful employment.

Reduction of those employed in agriculture will boost productivity of rural agriculture tremendously as it will result in a smaller number of farmers managing a larger area giving rise to economies of scale enabling the production of a greater output at a lower unit cost.

The resulting reduction of encroachment of forest lands due to land hunger on account of farm fragmentation will lead to an abatement of the human-elephant conflict and a reduction of the felling of trees in catchment areas of streams and rivers.

If it also results in crops selected on the basis of further processing possibilities being grown on a large scale, urban clusters could be set up, where factories and services could be located to process the surplus primary produce of the farms.

This will lead to the expansion of the food, beverages and tobacco sector among manufactured exports. This sector had contributed only 3.5% of total exports in 2012. Being a country with an agricultural hinterland, this is a shame.

Reforms of this type can be recommended for alleviation of poverty and reduction of inequality of income as agriculture directly or indirectly supports about 17 million people in Sri Lanka. The urban sector also will benefit with an abundance of cheap food as agricultural productivity will also increase.

This is one of the reforms that will give alternative employment to those in rural areas seeking employment abroad.

Most of the opposition parties devote much of their time shouting about price increases which do not affect the rural sector so much. Not much voice is given to the essential needs of farmers connected to land, irrigation, planting material, credit and marketing of produce. No wonder they are losing elections.

Another reason why manufacturers are important is that when they are accompanied by agriculture, generate additional services in the value chain and not the other way around.

Singapore is a unique case like Hong Kong.

It is city state without a hinterland for development and its governments have worked hard over several decades to attract services from far and wide by developing a public service that is one of the most efficient and also the infrastructure including the managerial, technical and the soft skills such as ability to communicate in foreign languages and be creative as demanded by multinationals.

Conclusions

SL being a small country with a small domestic market has to export to speed up economic growth and earn sufficient foreign exchange to solve its balance payments and foreign debt problems.

It has to reduce its dependence on commodity exports such as tea and low value adding products such as apparel and opt for manufacture (and allied services) like its spectacularly successful South East Asian counterparts.

The 2014 Budget presents two different strategies - one for import substitution and a just emerging export strategy; the puzzle is how these can be reconciled with each other? There is no alternative other than relying on achieving national export competitiveness.

Competitiveness with improved productivity and innovation for differentiation alone is insufficient.

A conducive and business friendly environment to attract investment particularly large and reputed FDI to create capacity for production of (manufactured) goods and services for export has to be created; if that can be achieved most of the tax incentives which add to the budget deficit may not be necessary.