Impact of the global recession on Sri Lanka:

Time to improve productivity

by Lloyd F. Yapa

This is a continuation of the paper on the same subject published in this newspaper a fortnight ago. In Part 1 we stated that the productivity/competitiveness of firms is directly affected by the effectiveness of the success of their goals and strategies in satisfying customer expectations/preferences and indirectly (though strongly) affected by governance and government. Discussion of the latter was taken up first and is continued in this part as well.

Part 2

Factor creation and development is an important strategy of improvement of productivity as they contribute in large measure to reduce costs and enhance quality/value addition. First, the factors of production are the natural or physical resources including land, human resources, capital resources, infrastructure and services and knowledge resources, e.g. the stock and standard of scientific, technical, market and management knowledge. The development of factors (to improve productivity) is mainly a responsibility of government.

Land

More than 80% of land in SL is owned by the Government, which has been leasing out some of it in small parcels of about 3 acres to landless villagers to cultivate rice, especially under its irrigation schemes during the last 60 years or so under the Land Development Ordinance.

Most of these farms have been unviable; probably due to the fact that agriculture or more specifically rice cultivation is not profitable unless undertaken on a large-scale to bring down unit costs and increase value addition to the produce.

Government could therefore introduce ways and means of getting the small farmers to undertake cropping and value addition on the produce as a large-scale joint operation, e.g. by forming joint stock companies.

Labour

The labour laws in Sri Lanka have not been drawn up with an eye to improving productivity, but on granting permanence to workers. Firms cannot dismiss employees even for valid reasons without getting the approval of the Labour Department; this is a long and costly procedure. Wages in Sri Lanka do not find the most competitive level as they are not decided on the basis of supply and demand factors due to the rigidity of labour laws. Wages are also not decided on the basis of productivity. Labour costs are therefore too high.

The majority in the labour force are unskilled workers due to the paucity of formal systems to certify their level of training like the City and Guilds system prevalent in the UK.

Highly skilled labour like engineers and scientists required to improve productivity is scarce due to the low enrolment rates to the universities and other tertiary educational institutions, especially for science and technology streams.

Moreover the outflow of skilled and qualified personnel or the 'brain drain' is very serious (reported to be around 50,000 per year) due mainly to the prevailing socio-political uncertainties.

There is no doubt that these daunting problems have to be rectified by government to improve Sri Lankan productivity/competitiveness vis a vis the rest of the world.

Capital

The capital and debt market is yet undeveloped in the country and finding equity and loan financing on reasonable terms for investments e.g. for improving productivity and for expansion of production as in the case of SMEs is no easy task. Financial institutions in SL are still very conservative and demand land and other fixed assets as collateral. Most enterprises have no collateral to offer in addition to facing heavy documentation and are often driven into the arms of usurious money lenders.

Financial institutions have been compelled to charge higher interest rates due to escalating levels of inflation generated mainly by the budget deficits run by almost all governments. The efforts made to rectify these problems need to be re-examined to improve productivity.

The levels of Foreign Direct Investment (FDI) flows of good repute which can also bring in technologies and management skills that the country lacks (to improve productivity) as well as knowledge of markets to enable large-scale production have been low in Sri Lanka compared to those in respect of countries like China, Singapore, Hong Kong and even Malaysia (US $ 37.4 billion compared Sri Lanka's US $ 1.5 billion during the period 1995-2004, World Development Reports, 2000 and 2003 )perhaps due to continued socio/economic/political instability arising on account of poor governance and our inability to solve the ethnic crisis.

Infrastructure

Physical infrastructure facilities include roads, railways, harbours, irrigation channels and reservoirs. Government investment in Sri Lanka in these areas (as well as services such as health and education) during the last ten years or so has been about 6% of GDP compared to more than 10% of GDP in some Asian countries.

Productivity has therefore suffered tremendously mainly due to costs of transport including waste.

Education

The absence of advanced and specialized factors (in various areas of knowledge e.g. science and technology) and the proficiency in English(required to obtain the learning necessary to improve productivity) and the presence only of low level skills compels firms in Sri Lanka to compete on price which can easily be nullified by other competitors whose supply of labour is much cheaper as in China. According to the book "Trade Liberalization in Sri Lanka", by Ganeshan Wignaraja, 1998, the ratio of high to low skill intensity of Sri Lanka export products in 1992 was 0.08 compared to 1.82 in South Korea and 1.37 in Taiwan. There is no reason to believe the ratio has improved significantly since then due to the inability of the system of education to produce Science and Technology(S&T) personnel, low expenditure on Research &Development and the unimpressive levels of transfer of technologies through FDI.

At a seminar held at the OPA on education perspectives on 06/05/2009 a retired educationist made the most alarming statement that emphasis on teaching of S&T is not emphasized in our system of education as it is not an essential requirement for increasing productivity! No wonder the competitiveness of our exports is at low ebb.

Apart from the fact not enough skills are produced in SL there is an alarming outflow of skilled persons of about 50,000 per year from the country for employment abroad and additional 7,000-10,000 leaving the country for higher education every year as the public education system does not provide tertiary facilities to as many as 80% of students. Some of the latter never comeback due perhaps to the environment of socio political instability prevailing in the country for the last several decades.

Supporting industries

The next important determinant of improvement of productivity/competitiveness is the presence of (large clusters of) supporting industries (supplying inputs and helping in distributing outputs)

Such related industries tend to co-operate in the various activities in the value chain of an industry to reduce costs and add value, if encouraged by the main buyer firms (as in the case of Toyota and Honda automobiles).

Such clusters need to be developed in Sri Lanka; if they are product oriented so much the better. The various industrial estates set up by State agencies in the country cannot be described as large-scale clusters of supporting industries contributing to economies of scale and value addition.

Demand for goods and services

Productivity of firms catering to segments (with large and sophisticated demand) in which they have captured significant share of the market and so could achieve economies of scale is generally high. Domestic demand or the market for goods and services in Sri Lanka is small because* *persons with purchasing power in terms of income constitute less than 20% of the population (of 20 million). Therefore foreign demand for such products and services, preferably with customer preferences similar to those of the domestic market has to be increased for Sri Lanka to succeed in exports. The large Indian market of about 350 million middle class people with a per cap income of about PPP US $ 5,000-10,000 next door to our country fills the bill, though numerous non tariff barriers and unethical business practices have to be overcome.

Goals and strategies of firms

This is the direct determinant of productivity and competitiveness. Nations do not compete directly in international trade and industry. It is the firms which do; therefore it is they who have to enhance their competitiveness by way of reducing costs and adding value to meet customer needs.

Although it is up to the firms to adopt appropriate goals and strategies to improve productivity, it is the responsibility of the Government to promote competition or rivalry among them to pressurize them to innovate/differentiate, to add value and reduce costs of products and services by investing in research, development of technologies, improving skills for upgrading and innovations to products and services, as firms tend to dislike strong competition. This has to be done by reducing protection, discouraging the formation of monopolies, encouraging the entry of new firms by simplifying approval and registration procedures and other external pressures like conforming to the highest international standards of quality, attracting demanding buyers in addition to helping firms to invest in expansions, new projects and diversifications to achieve scale economies. Government should also encourage collaboration among firms in vertical value chain activities such as procurement of inputs, production and marketing as it is necessary to lower costs and add value.

Other Government measures to improve productivity in firms include the following:

i. Foreign investment, especially by reputed foreign firms contributing to sustained investments, transfer of technologies, and training of local personnel and establishment of backward links.

ii. Privatize the business enterprises owned by the Government to some extent at least as their productivity is reported to be very low due to low investment on the latest technologies, the absence of a habit of making appointments on merit as well as aversion to take risks, extreme politicization and toleration of bribery and corruption.

To summarize, a recession bringing with it suffering on account of loss of incomes is a good time to improve productivity (and competitiveness) by reducing costs of production and adding value (in terms of customer preferences) to products and services to enable higher earnings, especially when the world recovers from it. This is the direct responsibility of firms and indirectly (though strongly) related to governance and government as the latter determines the productivity and competitiveness of firms.

The people therefore should understand the methodologies to be adopted for this purpose and urge the Government to take appropriate action - by improving the quality of governance and government.

More specifically it involves adoption of fiscal and monetary policies to restore economic stability, creating rivalry among firms to induce innovation to reduce costs and value addition in terms of customer preferences for them to earn higher profits and assisting the firms in this endeavour by creation/development of factors of production (especially development of education and infrastructure), raising demand among the majority of people by equitable distribution of incomes as well as developing supporting industries to induce large-scale production and supply of quality inputs and extending tax/financial incentives.