Impact of global recession on Sri Lanka:

Time to improve productivity

by Lloyd F. Yapa

The impact of the global recession (low demand for goods and services due to a decline in the incomes of consumers) is upon us in Sri Lanka with a rage-export both direct and indirect)related firms are either closing down or are reducing their workforces. Unlike in the case of China, a country with considerable demand because of its the large population of well over a billion people, we cannot rely on domestic demand to bail out the economy; in the case of Sri Lanka 70% of our 20 million people live in rural areas; they are basically poor and their demand for goods and services is rather low. So therefore we have to rely on some other way of dealing with the problem of closure of (export related) enterprises or reduction of employment due to losses incurred on account of low demand for products and services. That other way is undoubtedly improving the competitiveness of the goods and services we supply for export for profits of firms to be increased along with foreign exchange earnings. What this means is the productivity of the entire economy, not only of the export sector, has to be improved significantly.

If we can achieve this, the country will be ready to face the worst of the recession as well as the expected upsurge in demand once the world recovers from the recession.

Productivity or yield/output in terms of factors of production such as labour and capital is the measure of competitiveness which involves examination of two items - the cost and value added per unit of production; if the productivity/competitiveness of a firm is high, it means that either the cost per unit of production is lower (due to distribution of fixed costs over a large volume of output-economies of scale) than that of competitors or the value addition due to differentiation of the product to suit customer preferences is higher enabling sales to take place at a higher price per unit or both. A competitive advantage of a firm (unlike a comparative advantage or ability to produce at a lower resource cost than others) has been described as something that rivals cannot match either on the basis of cost per unit or value addition.

An analysis of GDP per worker as an indication of the productivity of our labour vs those of some other Asian countries indicates the massive uphill task facing the country to improve its competitiveness in order to increase its earnings from exports. The GDP per worker of Sri Lanka in 2005 was $ 11,811 in comparison with $27,438 in Malaysia (and $63,064 in Japan) according to the APO Productivity Data Book, 2008.

Determinants

The direct determinant of competitiveness of a country is the productivity of firms producing goods and services, which in turn is determined by the effectiveness of the goals and strategies adopted by them in delivering customer expectations. The competitiveness of firms is indirectly decided by the effectiveness of governance and government in influencing sociopolitical and economic stability and more specifically the policies (e.g. fiscal and monetary policies) and actions of government on a sustainable basis. Good governance begets the socio political and economic stability which is a prerequisite for robust and sustained action by firms at investment and productivity improvement for enhancing revenues and profits. Thus the more stable countries in the region have attracted more FDI compared to Sri Lanka and grown faster. For example South Korea and Malaysia have attracted US$ 7.7 bln and US $ 4.6 bln respectively compared to US $ 0.233 in the case of Sri Lanka in 2004 (World Development Reports 2000 and 2003). Governance and government also determine, a) the prevailing price levels, b) the intensity of rivalry/competition among firms to catch the eye of the customer leading to cost reduction and value addition, c) the quality (and volume) of factors of production (labour, capital etc.) and d) the quality of infrastructure and e) the quality and extent of supporting industries and services.

Governance and government

The role of good governance and government has to be discussed first owing to its all pervading influence on productivity and competitiveness of firms although it influences them indirectly. (Good) governance is the result of the quality and neutrality of the (democratic) processes, institutions and the officials that form part and parcel of government. In particular good governance is ensured among certain other factors by,

i. The separation of powers among the executive(public service), the judiciary and the legislature by constitutional means to ensure an absence of political interference from decision making by the government;

ii. Recruitment and promotion of employees based on merit and not on political influence; this is the reason the 17th Amendment to the Constitution including the establishment of a neutral Constitutional Council has to be implemented in full.

(It is mainly these two factors which determine the quality of the services of public institutions and the effectiveness of their policies/programmes and therefore ultimately of sustained real income growth in terms of purchasing power which could reduce poverty; neglect of this requirement will ensure social unrest and the continuation of poverty).

iii. Well enforced accountability systems and a well trained free media; iv. A decision making system that is transparent and allows participation of employees, (citizens) and delegation of authority, (therefore devolution to regions where necessary).

There are certain weaknesses in the (1978) constitution such as:

a) the non separation of the executive (public service) and the judiciary from the legislature leading to politicization of these two arms of the government,

b) the weaknesses in the provisions pertaining to devolution of power to the provinces,

c) weaknesses in electoral laws that make elections expensive , do not give representation to specific constituencies and the tendency to elect minority governments which tend to run budget deficits due to expansion of vote catching welfare measures) and

d) the absence of effective laws pertaining to offences such as corruption.

Good governance cannot be created by legislation alone; it is the conduct of the people that matters most. Right (disciplined) conduct is brought about by possession of moral values; in the first instance a keen sense of right and wrong, personal discipline and an achievement orientation on the part of individuals is necessary ;( this is described as self management).

The other side of the coin is social management or the tolerance of opposing views, conflict resolution and achievement of socio economic goals. This appears to be absent among most of us going by the ethnic conflict and poor law and order situation that has prevailed in the country.

As a result of the above mentioned weaknesses in governance leading to acute politicization, the quality and effectiveness of the executive including the public service in Sri Lanka have certainly suffered over the last few decades. Particular reference should be made to the profligate fiscal and monetary as well as micro economic policies of SL governments since Independence in 1948 (that have pushed up costs and prices due to rising inflation and undermined competitiveness) and the injustices suffered by people mainly on account of the law enforcement authorities succumbing to political pressure. Above all the instability created has not only reduced investment, but also prompted a 'brain drain', lowered enthusiasm for innovation to add value and have encouraged large scale corruption, all of which tend to reduce productivity and income growth.

The specific strategies that a government has to implement for promotion of productivity/competitiveness are as follows:

Policies, Incentives and Regulations

Macro policies (fiscal and monetary) should encourage price stability or avoidance of price fluctuations. Most SL governments have tended to run budget deficits (and current account deficits) with the result that price escalations have been the order of the day.

Inflation (or a general increase in the price level over time) has been accompanied by high interest rates, both of which have pushed up costs unfavourably affecting profit margins of investors and the competitiveness of their enterprises.

Examination of the rates of inflation from 1995 to 2008 in several Asian countries shows that the Sri Lanka rate has been the highest most of the time.The other policies and incentives that should be introduced for raising the level of productivity/competitiveness are as follows:

i. Tax concessions should be available for long-term capital gains and to build reserves to encourage a sustained rate of high investment to improve competitive advantage. Marginal rates of income and corporate tax on the higher income slabs should be low enough to encourage the effort. In Sri Lanka it increases from an average of about 30% to about 35% on the higher slabs. In practice the imposition of various levies on top of direct (corporate) taxes has tended to erode profit margins of firms seriously; the latest level of taxation of firms is reported to be 50% which is very high.

ii. The present tendency of policies aimed at protecting domestic enterprises heavily such as high import tariffs should be discouraged. It reduces competition among firms, the pressure to innovate and make them sluggish and complacent at reducing costs and adding value and lead to failure when new competitors who can match them emerge. Such a debacle would seriously compromise the ultimate goal of achieving economic prosperity in Sri Lanka.

iii. Supporting research and development (to enable value addition) in specialized research universities, which have links with industry associations, and industrial clusters rather than in government laboratories as in SL should be encouraged as they can create generation after generation of new Science and Technology (S&T) personnel and diffuse knowledge. Research and Development expenditure in SL, however, happens to be at a very low level of about 0.18 % of GNP (reported to have come down to 0.13 lately) compared to 2.8% in Japan and 1.9 % in S. Korea according to the book, "Trade Liberalization in Sri Lanka" by G. Wignaraja.

iv. Supporting research in firms keen on innovation to add value by providing matching funds or part subsidization to retain their commitment could also be more productive than research by government laboratories if properly monitored.

v. A policy of great significance in Sri Lanka, where the public institutions are notoriously inefficient is to substantially reduce the so called 'transaction costs' incurred by firms and individuals when dealing with a profusion of government institutions arising from overlapping functions, cumbersome procedures, inefficiency and corruption.

High transaction costs are the bane of enterprises especially SMEs in Sri Lanka as they impact unfavourably on improvement of productivity.

(To be continued)