Abstract
Selected Issues
Sri Lanka: Structural Transformation—the New Frontier1
With its relatively static trade structure, Sri Lanka lacks the economic complexity and diversification expected of a middle-income Asian economy. Simplifying tax policy, gradually liberalizing tariffs and para-tariffs, and easing the regulatory burden on businesses could help restore competitiveness, private-sector dynamism, and increase the country’s productivity.
1. Sri Lanka is ready to shift towards more private-sector-led growth, building on its significant upgrade in infrastructure after the war and ongoing reform efforts. Sri Lanka has gone through defining transitions over the past decade. In 2009, the country embarked in a major post-war scale up of infrastructure in a relatively brief period. Reforms continued in 2015, following a peaceful and democratic transition of power to the coalition government. The current economic environment offers a window of opportunity for evaluating remaining structural weaknesses and working towards macro-economic resilience and enhancing competitiveness. Among others, simplification of tax systems, including trade tariffs and para-tariffs, through predictable, fair, and automated mechanisms, can remove uncertainties that hold back trade and investment decisions and support the needed shift towards more private sector-led growth. Stable and transparent regulatory systems would also make Sri Lanka’s business environment more attractive for long-term foreign investment and support trade integration.
A. Growth Story
2. Sri Lanka has a compelling growth story. The economy has grown at an average of 5 percent over the last four decades, amidst the 30-year civil conflict, weather calamities, and swings in economic policy orientation depending on ruling parties’ ideology. Sri Lanka seesawed between protectionist and liberalization strategies: state control and import substitution in early 70s; two waves of liberalization in early 80s and 90s; closing up again in early 2000s at the height of the war; and then opening up again since the end of the war (text table below).
3. Strong economic growth has led to a significant decline in poverty rates (text table below). While a recent IMF study (IMF, forthcoming) finds that emerging markets experienced a significant increase in average growth rates in the 2000s, particularly in Asia, only half of these emerging markets are converging with developed countries in per capita income levels. Remarkably, Sri Lanka has halved its poverty gap over the last decade. Nevertheless, challenges in terms of inclusiveness, regional disparities, quality of education, and gender equality remain.2
Sri Lanka: Economic Policy Orientation 1970–20181
Athukorala and Rajapatirana, S. (2000) and Athukorala (2017).
Sri Lanka: Economic Policy Orientation 1970–20181
| Period | Status | Key policies |
|---|---|---|
| 1970–1977 | State control and import-substitution industrialization strategy | Since 1960, a combination of change in political leadership and balance of payments challenges led to the government’s adoption of protectionist import substitution industrialization policies. 1970–1977 saw further government intervention through efforts in creating a socialist society. |
| 1977–1987 | Liberalization | The first round of reforms carried out during 1977–79 included,
|
| 1988–2002 | Second wave of liberalization in the 1990s | The impact of the first round of liberalization reforms was not fully realized. Delays and inconsistencies in the implementation of the reforms affected the ability to attract FDI. The conflict limited economic activities to 2 provinces (12 percent of the population). The second round of liberalization was implemented in 1990 and included privatization and deregulatory reforms (e.g., privatization of telecommunications and conversion of large plantations to the private sector under 100-year lease agreements). Import tariffs were rationalized in 1993 to a three-band tariff structure and in 1997 all textile tariffs were abolished. |
| 2002–2009 | Closing up before the end of the war in 2009 | Following the second wave, the reform process began to lose momentum due to fiscal pressures to finance the civil war and an economic recession. For example, the planned reduction of tariffs into single band was abandoned and tariffs started to be adjusted frequently in an ad-hoc manner. |
| 2010–2018 | Post-war infrastructure scale up and ongoing reforms | Rapid infrastructure development of rural and conflict-affected areas of the country and the revival of the SME sector were the key policy priorities under the new policy. The current coalition government, elected in 2015, has stated its commitment to outward oriented, knowledge-based social market economy in its Vision 2025 program. |
Athukorala and Rajapatirana, S. (2000) and Athukorala (2017).
Sri Lanka: Economic Policy Orientation 1970–20181
| Period | Status | Key policies |
|---|---|---|
| 1970–1977 | State control and import-substitution industrialization strategy | Since 1960, a combination of change in political leadership and balance of payments challenges led to the government’s adoption of protectionist import substitution industrialization policies. 1970–1977 saw further government intervention through efforts in creating a socialist society. |
| 1977–1987 | Liberalization | The first round of reforms carried out during 1977–79 included,
|
| 1988–2002 | Second wave of liberalization in the 1990s | The impact of the first round of liberalization reforms was not fully realized. Delays and inconsistencies in the implementation of the reforms affected the ability to attract FDI. The conflict limited economic activities to 2 provinces (12 percent of the population). The second round of liberalization was implemented in 1990 and included privatization and deregulatory reforms (e.g., privatization of telecommunications and conversion of large plantations to the private sector under 100-year lease agreements). Import tariffs were rationalized in 1993 to a three-band tariff structure and in 1997 all textile tariffs were abolished. |
| 2002–2009 | Closing up before the end of the war in 2009 | Following the second wave, the reform process began to lose momentum due to fiscal pressures to finance the civil war and an economic recession. For example, the planned reduction of tariffs into single band was abandoned and tariffs started to be adjusted frequently in an ad-hoc manner. |
| 2010–2018 | Post-war infrastructure scale up and ongoing reforms | Rapid infrastructure development of rural and conflict-affected areas of the country and the revival of the SME sector were the key policy priorities under the new policy. The current coalition government, elected in 2015, has stated its commitment to outward oriented, knowledge-based social market economy in its Vision 2025 program. |
Athukorala and Rajapatirana, S. (2000) and Athukorala (2017).
Sri Lanka: Poverty and Inequality, 2002–2016
Sri Lanka: Poverty and Inequality, 2002–2016
| 2002 | 2006/2007 | 2009/2010 | 2012/2013 | 2016 | ||
|---|---|---|---|---|---|---|
| Poverty indicators | ||||||
| Poverty headcount ratio (percent of population) | ||||||
| US$1.90 a day (2011 PPP) | 8.3 | 3.8 | 2.4 | 1.9 | 0.7 | |
| National poverty lines | 22.7 | 15.3 | 8.9 | 6.7 | 4.1 | |
| Poverty gap (percent) | 5.1 | 3.1 | 1.7 | 1.2 | 0.6 | |
| Severity (percent) | 1.6 | 0.9 | 0.5 | 0.3 | 0.1 | |
| Inequality indicators | ||||||
| Gini coefficient | 0.40 | 0.40 | 0.36 | 0.39 | 0.45 | |
| Theil index | 0.32 | 0.33 | 0.27 | 0.32 | … | |
| p90/p10 ratio | 5.12 | 4.98 | 4.30 | 4.74 | … | |
Sri Lanka: Poverty and Inequality, 2002–2016
| 2002 | 2006/2007 | 2009/2010 | 2012/2013 | 2016 | ||
|---|---|---|---|---|---|---|
| Poverty indicators | ||||||
| Poverty headcount ratio (percent of population) | ||||||
| US$1.90 a day (2011 PPP) | 8.3 | 3.8 | 2.4 | 1.9 | 0.7 | |
| National poverty lines | 22.7 | 15.3 | 8.9 | 6.7 | 4.1 | |
| Poverty gap (percent) | 5.1 | 3.1 | 1.7 | 1.2 | 0.6 | |
| Severity (percent) | 1.6 | 0.9 | 0.5 | 0.3 | 0.1 | |
| Inequality indicators | ||||||
| Gini coefficient | 0.40 | 0.40 | 0.36 | 0.39 | 0.45 | |
| Theil index | 0.32 | 0.33 | 0.27 | 0.32 | … | |
| p90/p10 ratio | 5.12 | 4.98 | 4.30 | 4.74 | … | |
4. The remainder of the paper is organized as follows. A growth accounting framework is used in this section to investigate the main sources of growth in Sri Lanka during the period of 1960–2016, including through sectoral decomposition and reallocation effects. The following section presents an overview of competitiveness challenges and reform opportunities going forward.
Aggregate TFP Accounting
5. A simple Solow residual growth accounting shows that capital was the most important contributor to growth over the past five decades.3 Capital accumulation peaked after the trade and economic policy liberalization of the late-70s driven by FDI inflows, dropped during the war, and picked up again with the reconstruction since 2010. With the opening up of the economy in the 70s, TFP contribution to growth also improved considerably reaching about 3 percent even during the height of the war (text table) and exceeded the average for emerging markets.
Total Factor Productivity Residual
(Average across time period, in percent)
Citation: IMF Staff Country Reports 2018, 176; 10.5089/9781484362358.002.A001
Source: IMF (2018) and staff calculations.Total Factor Productivity Residual
(Average across time period, in percent)
Citation: IMF Staff Country Reports 2018, 176; 10.5089/9781484362358.002.A001
Source: IMF (2018) and staff calculations.Total Factor Productivity Residual
(Average across time period, in percent)
Citation: IMF Staff Country Reports 2018, 176; 10.5089/9781484362358.002.A001
Source: IMF (2018) and staff calculations.6. The war is also found to have significantly affected production factor utilization rates. Factor utilization adjustment is a relevant concept in empirical studies of re-organization of production structures in an economy due to a war or a major economic transition.4 It allows to better capture factor contributions versus TFP residual and separate contribution of sectoral reallocation effects discussed later in the section. In the case of Sri Lanka, capital utilization rates have dropped considerably at the peak of the war, while labor utilization rates have also been possibly affected by recurrent natural disasters (Annex I).
Sri Lanka: Sources of Growth – Solow Residual, 1961–2016
(Average growth rate, in percent)
Sri Lanka: Sources of Growth – Solow Residual, 1961–2016
(Average growth rate, in percent)
| Output | Employment | Capital | Output per Worker | Contribution of: | ||
|---|---|---|---|---|---|---|
| Capital per Worker | Factor Productivity | |||||
| 1961–70 | 4.7 | 2.5 | 9.5 | 2.2 | 2.1 | 0.1 |
| 1971–77 | 2.9 | 1.7 | 9.0 | 1.2 | 2.2 | −1.0 |
| 1978–87 | 5.4 | 2.9 | 11.0 | 2.5 | 2.4 | 0.1 |
| 1988–02 | 4.6 | 1.1 | 4.5 | 3.5 | 1.0 | 2.5 |
| 2003–09 | 6.0 | 1.6 | 5.4 | 4.3 | 1.1 | 3.2 |
| 2010–16 | 6.3 | 1.1 | 7.8 | 5.1 | 2.0 | 3.1 |
Sri Lanka: Sources of Growth – Solow Residual, 1961–2016
(Average growth rate, in percent)
| Output | Employment | Capital | Output per Worker | Contribution of: | ||
|---|---|---|---|---|---|---|
| Capital per Worker | Factor Productivity | |||||
| 1961–70 | 4.7 | 2.5 | 9.5 | 2.2 | 2.1 | 0.1 |
| 1971–77 | 2.9 | 1.7 | 9.0 | 1.2 | 2.2 | −1.0 |
| 1978–87 | 5.4 | 2.9 | 11.0 | 2.5 | 2.4 | 0.1 |
| 1988–02 | 4.6 | 1.1 | 4.5 | 3.5 | 1.0 | 2.5 |
| 2003–09 | 6.0 | 1.6 | 5.4 | 4.3 | 1.1 | 3.2 |
| 2010–16 | 6.3 | 1.1 | 7.8 | 5.1 | 2.0 | 3.1 |
7. However, the post-war capital injection does not appear to have resulted in immediate TFP enhancements, taking factor utilization rates into account. The contribution of capital accumulation to growth picked up during the post-war reconstruction period, driven by mega-scale public infrastructure development projects. Interestingly, the TFP residual halved during this period and has continued to decline in recent years.5 Unlike the 70–80s when capital deepening was mainly driven by investments in tradable sectors and followed by a significant productivity pick up,6 the nature of the post-war capital deepening was different, mainly driven by mega-scale infrastructure projects financed by the public sector and FDI remained stagnant, below 2 percent of GDP since 1998 (text table below).7 Reforms to ease the business environment and trade are still at the early stages of implementation. As showed by other episodes of infrastructure scale-up in different countries, business environment liberalization is an important catalyst of private sector led growth.8
Sri Lanka: Sources of Growth, Adjusted for Utilization, 1961–2016
(Average growth rate, in percent)
Sri Lanka: Sources of Growth, Adjusted for Utilization, 1961–2016
(Average growth rate, in percent)
| Output | Employment | Capital | Output per Worker | Contribution of: | ||
|---|---|---|---|---|---|---|
| Capital per Worker | Factor Productivity | |||||
| 1961–70 | 4.7 | … | … | … | … | … |
| 1971–77 | 2.9 | 5.2 | 7.7 | −2.3 | 0.7 | −3.0 |
| 1978–87 | 5.4 | 2.8 | 14.2 | 2.6 | 3.4 | −0.8 |
| 1988–02 | 4.6 | 1.0 | 4.7 | 3.6 | 1.1 | 2.5 |
| 2003–09 | 6.0 | 1.9 | 1.7 | 4.1 | −0.1 | 4.1 |
| 2010–16 | 6.3 | 0.9 | 12.0 | 5.4 | 3.3 | 2.1 |
Sri Lanka: Sources of Growth, Adjusted for Utilization, 1961–2016
(Average growth rate, in percent)
| Output | Employment | Capital | Output per Worker | Contribution of: | ||
|---|---|---|---|---|---|---|
| Capital per Worker | Factor Productivity | |||||
| 1961–70 | 4.7 | … | … | … | … | … |
| 1971–77 | 2.9 | 5.2 | 7.7 | −2.3 | 0.7 | −3.0 |
| 1978–87 | 5.4 | 2.8 | 14.2 | 2.6 | 3.4 | −0.8 |
| 1988–02 | 4.6 | 1.0 | 4.7 | 3.6 | 1.1 | 2.5 |
| 2003–09 | 6.0 | 1.9 | 1.7 | 4.1 | −0.1 | 4.1 |
| 2010–16 | 6.3 | 0.9 | 12.0 | 5.4 | 3.3 | 2.1 |
Sectoral Decomposition and Factor Reallocation
8. Sri Lanka’s economic structure has also changed over the years. The contribution of agriculture to output and employment declined over the years as labor moved to manufacturing and other sectors. While agriculture and manufacturing employ a significant share of the population, services, construction, and other sectors have become with time the main employers and output drivers in Sri Lanka (text table below).
Sri Lanka: Sectoral Shares, 1960–2016
(In percent)
Sectoral Share in Employment as of 1963.
Sri Lanka: Sectoral Shares, 1960–2016
(In percent)
| Sectoral Shares in Output | Sectoral Shares in Employment | |||||
|---|---|---|---|---|---|---|
| Agriculture | Manufacturing | All Other Sectors | Agriculture | Manufacturing | All Other Sectors | |
| 1960* | 26 | 16 | 58 | 53 | 9 | 38 |
| 1971 | 22 | 19 | 59 | 49 | 9 | 42 |
| 1978 | 21 | 16 | 63 | 49 | 12 | 39 |
| 1988 | 17 | 17 | 66 | 45 | 13 | 42 |
| 1990 | 17 | 18 | 65 | 45 | 13 | 42 |
| 2003 | 11 | 21 | 68 | 32 | 16 | 53 |
| 2010 | 9 | 20 | 70 | 31 | 16 | 54 |
| 2016 | 8 | 17 | 75 | 25 | 17 | 58 |
Sectoral Share in Employment as of 1963.
Sri Lanka: Sectoral Shares, 1960–2016
(In percent)
| Sectoral Shares in Output | Sectoral Shares in Employment | |||||
|---|---|---|---|---|---|---|
| Agriculture | Manufacturing | All Other Sectors | Agriculture | Manufacturing | All Other Sectors | |
| 1960* | 26 | 16 | 58 | 53 | 9 | 38 |
| 1971 | 22 | 19 | 59 | 49 | 9 | 42 |
| 1978 | 21 | 16 | 63 | 49 | 12 | 39 |
| 1988 | 17 | 17 | 66 | 45 | 13 | 42 |
| 1990 | 17 | 18 | 65 | 45 | 13 | 42 |
| 2003 | 11 | 21 | 68 | 32 | 16 | 53 |
| 2010 | 9 | 20 | 70 | 31 | 16 | 54 |
| 2016 | 8 | 17 | 75 | 25 | 17 | 58 |
Sectoral Share in Employment as of 1963.
9. The productivity of the manufacturing sector has been declining since the 1990s. Manufacturing sector TFP has dropped despite growing capital investments.9 In 2010–2016, capital per worker in manufacturing sector almost doubled, while TFP has significantly declined. The recent agricultural growth was mainly driven by better access to land in the Eastern and Northern provinces previously affected by the conflict. Construction and services are the fastest growing sectors with the highest productivity rates. Expansion of real estate, logistics, transport, and tourism related services quickly followed the post-war infrastructure scale up (text table below).
Sri Lanka: Sectoral Growth Accounting, Adjusted for Utilization, 1990–2016
(Average growth rate, in percent)
Sri Lanka: Sectoral Growth Accounting, Adjusted for Utilization, 1990–2016
(Average growth rate, in percent)
| Output | Employment | Capital | Output per Worker | Contribution of: | |||
|---|---|---|---|---|---|---|---|
| Capital per Worker | Factor Productivity | ||||||
| Agriculture Sector | |||||||
| 1990–2002 | 2.0 | −1.2 | 4.6 | 3.3 | 1.8 | 1.5 | |
| 2003–2009 | 3.4 | 1.0 | 0.3 | 2.5 | −0.2 | 2.7 | |
| 2010–2016 | 3.4 | −1.8 | 12.6 | 5.2 | 4.3 | 0.9 | |
| Manufacturing Sector | |||||||
| 1990–2002 | 6.7 | 3.2 | 2.1 | 3.5 | −0.3 | 3.8 | |
| 2003–2009 | 5.1 | 2.5 | 5.5 | 2.6 | 0.9 | 1.7 | |
| 2010–2016 | 3.6 | 1.0 | 8.2 | 2.6 | 2.2 | 0.5 | |
| All Other Sectors (Construction and Services) | |||||||
| 1990–2002 | 5.0 | 2.8 | 4.6 | 2.2 | 0.6 | 1.7 | |
| 2003–2009 | 6.6 | 2.4 | 1.6 | 4.3 | −0.2 | 4.5 | |
| 2010–2016 | 7.3 | 2.2 | 12.1 | 5.1 | 3.0 | 2.1 | |
Sri Lanka: Sectoral Growth Accounting, Adjusted for Utilization, 1990–2016
(Average growth rate, in percent)
| Output | Employment | Capital | Output per Worker | Contribution of: | |||
|---|---|---|---|---|---|---|---|
| Capital per Worker | Factor Productivity | ||||||
| Agriculture Sector | |||||||
| 1990–2002 | 2.0 | −1.2 | 4.6 | 3.3 | 1.8 | 1.5 | |
| 2003–2009 | 3.4 | 1.0 | 0.3 | 2.5 | −0.2 | 2.7 | |
| 2010–2016 | 3.4 | −1.8 | 12.6 | 5.2 | 4.3 | 0.9 | |
| Manufacturing Sector | |||||||
| 1990–2002 | 6.7 | 3.2 | 2.1 | 3.5 | −0.3 | 3.8 | |
| 2003–2009 | 5.1 | 2.5 | 5.5 | 2.6 | 0.9 | 1.7 | |
| 2010–2016 | 3.6 | 1.0 | 8.2 | 2.6 | 2.2 | 0.5 | |
| All Other Sectors (Construction and Services) | |||||||
| 1990–2002 | 5.0 | 2.8 | 4.6 | 2.2 | 0.6 | 1.7 | |
| 2003–2009 | 6.6 | 2.4 | 1.6 | 4.3 | −0.2 | 4.5 | |
| 2010–2016 | 7.3 | 2.2 | 12.1 | 5.1 | 3.0 | 2.1 | |
10. The shift of employment towards more productive sectors has benefited overall productivity. The factor reallocation effect on overall growth has been positive and increased after the war. Labor has moved from relatively low productive sectors such as agriculture and manufacturing to more productive services and construction (text table below). The positive contribution of factor reallocation to growth has doubled since the war, after an almost three-fold drop during the war due to physical restrictions in affected regions.
Sri Lanka: Reallocation Effect on Growth Adjusted for Utilization, 1990–2016
(Average growth rate, in percent)
Sri Lanka: Reallocation Effect on Growth Adjusted for Utilization, 1990–2016
(Average growth rate, in percent)
| Output per Worker | Contribution to Growth | |||||||
|---|---|---|---|---|---|---|---|---|
| Agriculture | Manufacturing | All other sectors | Total | Agriculture | Manufacturing | All other sectors | Reallocation | |
| 1990–2002 | 3.3 | 3.5 | 2.2 | 3.8 | 0.5 | 0.6 | 1.5 | 1.2 |
| 2003–2009 | 2.5 | 2.6 | 4.3 | 4.1 | 0.3 | 0.5 | 2.9 | 0.4 |
| 2010–2016 | 5.2 | 2.6 | 5.1 | 5.4 | 0.5 | 0.5 | 3.6 | 0.8 |
Sri Lanka: Reallocation Effect on Growth Adjusted for Utilization, 1990–2016
(Average growth rate, in percent)
| Output per Worker | Contribution to Growth | |||||||
|---|---|---|---|---|---|---|---|---|
| Agriculture | Manufacturing | All other sectors | Total | Agriculture | Manufacturing | All other sectors | Reallocation | |
| 1990–2002 | 3.3 | 3.5 | 2.2 | 3.8 | 0.5 | 0.6 | 1.5 | 1.2 |
| 2003–2009 | 2.5 | 2.6 | 4.3 | 4.1 | 0.3 | 0.5 | 2.9 | 0.4 |
| 2010–2016 | 5.2 | 2.6 | 5.1 | 5.4 | 0.5 | 0.5 | 3.6 | 0.8 |
B. Competitiveness Challenges and Opportunities10
Trade Openness
11. Despite significant productivity growth in the post-war period, Sri Lanka has not been able to diversify exports and its share in global trade has been declining gradually. Unlike its East Asian neighbors, Sri Lanka’s export structure has not changed in decades and remains concentrated on garments, tea, and rubber products (Annex II). The static export structure reflects lack of competitive forces to drive trade dynamism, innovation, and diversification.
12. Sri Lanka’s weakness in trade competitiveness partly stems from its restrictive trade policies. According to trade policy indicators recently developed by the IMF, Sri Lanka’s trade and FDI regimes are more restrictive than the average emerging market in all key areas.11 In particular, the country is more distant from the emerging market average in the categories of trade facilitation performance and ease of starting a foreign business.12 These findings are consistent with those of the World Economic Forum’s Enabling Trade Index 2016, which scores Sri Lanka at 4.1 out of 7 mainly due to market access, tariff rates and tariffs faced in destination markets.
Sri Lanka: Overall Trade and FDI Regime
(0=least open country; 1=most open country)
Citation: IMF Staff Country Reports 2018, 176; 10.5089/9781484362358.002.A001
Notes: The indicators reflect no judgement as to WTO compliance of underlying measures, nor whether certain measures (such as trade defense) are an appropriate response to the action of other countries. The “ease of starting a business” indicator is based on perceptions as part of an established IFC survey process. Year of data is in square brackets. Available indicators are presented for Sri Lanka. Please see IMF WP/18/32 for details.Sources: WTO, World Tariff Profiles; UNCTAD TRAINS and COMTRADE; OECD; WB STRI, World Bank; Global Trade Alert; and IMF staff estimates.Sri Lanka: Overall Trade and FDI Regime
(0=least open country; 1=most open country)
Citation: IMF Staff Country Reports 2018, 176; 10.5089/9781484362358.002.A001
Notes: The indicators reflect no judgement as to WTO compliance of underlying measures, nor whether certain measures (such as trade defense) are an appropriate response to the action of other countries. The “ease of starting a business” indicator is based on perceptions as part of an established IFC survey process. Year of data is in square brackets. Available indicators are presented for Sri Lanka. Please see IMF WP/18/32 for details.Sources: WTO, World Tariff Profiles; UNCTAD TRAINS and COMTRADE; OECD; WB STRI, World Bank; Global Trade Alert; and IMF staff estimates.Sri Lanka: Overall Trade and FDI Regime
(0=least open country; 1=most open country)
Citation: IMF Staff Country Reports 2018, 176; 10.5089/9781484362358.002.A001
Notes: The indicators reflect no judgement as to WTO compliance of underlying measures, nor whether certain measures (such as trade defense) are an appropriate response to the action of other countries. The “ease of starting a business” indicator is based on perceptions as part of an established IFC survey process. Year of data is in square brackets. Available indicators are presented for Sri Lanka. Please see IMF WP/18/32 for details.Sources: WTO, World Tariff Profiles; UNCTAD TRAINS and COMTRADE; OECD; WB STRI, World Bank; Global Trade Alert; and IMF staff estimates.13. The introduction of para-tariffs has significantly increased the degree of protectionism. Introduction of para-tariffs13 during the last decade has effectively doubled the protection rates making the present import regime one of the most complex and protectionist in the world.14 Para-tariffs not only increase monetary costs for firms but also procedural costs. A recent survey by the International Trade Center15 finds that the biggest challenges from para-tariffs are lack of information and extensive documentation as well as delays in processing, which is particularly hard to bear for small firms.
14. The most protected segments of the economy benefit from both high tariffs and para-tariffs. In addition, some sub-sectors have a third layer of protection on their inputs through selected tax holidays or exemptions. Consequently, the effective rate of protection (ERP) for the top 10 most protected sectors reach between 170 and 524 percent as of 2015 (text table).16 Interestingly, some of the most protected sectors do not necessarily represent strategic development or high employment activities, but appear effective in lobbying for protection.17 Moreover, the increase in the web of protective barriers seem to coincide with the decline in total contribution of state-owned establishments to sectoral value added (text table below). Furthermore, it appears that the government gave up direct ownership in some sectors, but simultaneously ensured the lasting protection of private companies in those same sectors.
Sri Lanka: Effective Rates of Protection
(Ranking across 105 sub-sectors, 1 = highest rate, 2015)
Citation: IMF Staff Country Reports 2018, 176; 10.5089/9781484362358.002.A001
Source: Department of Census and Statistics.Sri Lanka: Effective Rates of Protection
(Ranking across 105 sub-sectors, 1 = highest rate, 2015)
Citation: IMF Staff Country Reports 2018, 176; 10.5089/9781484362358.002.A001
Source: Department of Census and Statistics.Sri Lanka: Effective Rates of Protection
(Ranking across 105 sub-sectors, 1 = highest rate, 2015)
Citation: IMF Staff Country Reports 2018, 176; 10.5089/9781484362358.002.A001
Source: Department of Census and Statistics.Sri Lanka: Top Ten Most Protected Sectors in Manufacturing, 2015
(ERP range: 170–524 percent)
Sri Lanka: Top Ten Most Protected Sectors in Manufacturing, 2015
(ERP range: 170–524 percent)
| Ranking | Sector |
|---|---|
| 1 | Processing and preserving of fruit and vegetables |
| 2 | Manufacture of bakery products |
| 3 | Manufacture of macaroni, noodles, couscous and similar farinaceous products |
| 4 | Manufacture of refined petroleum products |
| 5 | Manufacture of refractory products |
| 6 | Distilling, rectifying and blending of spirits & Manufacture of wines |
| 7 | Manufacture of other porcelain and ceramic products |
| 8 | Manufacture of articles of concrete, cement and plaster |
| 9 | Manufacture of soft drinks; production of mineral waters and other bottled waters |
| 10 | Manufacture of dairy products |
Sri Lanka: Top Ten Most Protected Sectors in Manufacturing, 2015
(ERP range: 170–524 percent)
| Ranking | Sector |
|---|---|
| 1 | Processing and preserving of fruit and vegetables |
| 2 | Manufacture of bakery products |
| 3 | Manufacture of macaroni, noodles, couscous and similar farinaceous products |
| 4 | Manufacture of refined petroleum products |
| 5 | Manufacture of refractory products |
| 6 | Distilling, rectifying and blending of spirits & Manufacture of wines |
| 7 | Manufacture of other porcelain and ceramic products |
| 8 | Manufacture of articles of concrete, cement and plaster |
| 9 | Manufacture of soft drinks; production of mineral waters and other bottled waters |
| 10 | Manufacture of dairy products |
Sri Lanka: Contribution of Government Establishments in Manufacturing Value Added, 1970–2014
(In percent of total value added)
Sri Lanka: Contribution of Government Establishments in Manufacturing Value Added, 1970–2014
(In percent of total value added)
| 1970 | 1974 | 1981 | 1988 | 1993 | 1998 | 2005 | 2010 | 2014 | |
|---|---|---|---|---|---|---|---|---|---|
| Food, beverages and tobacco products | 24 | 42 | 42 | 44 | 17 | 19 | 7 | 3 | 2 |
| Textiles, wearing apparel and leather products | 11 | 37 | 72 | 39 | 1 | 11 | 0 | 0 | 0 |
| Wood and wood products | 73 | 92 | 92 | 74 | 46 | 35 | 14 | 27 | 63 |
| Paper and paper products | 43 | 69 | 66 | 45 | 38 | 19 | 3 | 2 | 0 |
| Chemical and chemical products, rubber and plastic products | 46 | 70 | 43 | 28 | 3 | 16 | 5 | 14 | 3 |
| Non-metallic mineral products | 72 | 82 | 87 | 60 | 28 | 50 | 3 | 1 | 0 |
| Basic metals, machinery and transport equipment | 87 | 91 | 46 | 31 | 15 | 8 | 0 | 0 | 0 |
| Total Manufacturing | 30 | 66 | 64 | 42 | 10 | 17 | 2 | 3 | 2 |
Sri Lanka: Contribution of Government Establishments in Manufacturing Value Added, 1970–2014
(In percent of total value added)
| 1970 | 1974 | 1981 | 1988 | 1993 | 1998 | 2005 | 2010 | 2014 | |
|---|---|---|---|---|---|---|---|---|---|
| Food, beverages and tobacco products | 24 | 42 | 42 | 44 | 17 | 19 | 7 | 3 | 2 |
| Textiles, wearing apparel and leather products | 11 | 37 | 72 | 39 | 1 | 11 | 0 | 0 | 0 |
| Wood and wood products | 73 | 92 | 92 | 74 | 46 | 35 | 14 | 27 | 63 |
| Paper and paper products | 43 | 69 | 66 | 45 | 38 | 19 | 3 | 2 | 0 |
| Chemical and chemical products, rubber and plastic products | 46 | 70 | 43 | 28 | 3 | 16 | 5 | 14 | 3 |
| Non-metallic mineral products | 72 | 82 | 87 | 60 | 28 | 50 | 3 | 1 | 0 |
| Basic metals, machinery and transport equipment | 87 | 91 | 46 | 31 | 15 | 8 | 0 | 0 | 0 |
| Total Manufacturing | 30 | 66 | 64 | 42 | 10 | 17 | 2 | 3 | 2 |
15. In order to address these challenges, as part of the Vision 2025 priorities, the government announced that it will adopt a time-bound plan to eliminate para-tariffs and conduct a comprehensive review of tariffs. The government has committed to eliminate 1200 lines of para-tariffs in the 2018 budget and is developing a 3-year plan to fully phase out remaining para-tariffs through subsequent budgets. Policy discussions are ongoing on a comprehensive review of tariffs and developing a time-bound plan for convergence to a relatively simplified structure. Streamlining the administrative processes and simplifying the structure of para-tariffs and tariffs will have a beneficial impact on trade.
Summary of Trade Reforms under the World Bank Program1
Sri Lanka launched various reforms under the World Bank’s trade and competitiveness program. The program, launched in March 2017, focuses on three areas: (i) improving the investment climate, (ii) eliminating barriers to trade, and (iii) fostering enterprise competitiveness. The following key achievements were made in each area:
• Improving the investment climate. The program aims to reform the business environment, enhance investment promotion, and strengthen the effectiveness of investment incentives. Under the program, the Investment Climate Reform Road Map and Action Plans were launched. Task Forces detailed time-bound actions to deliver. Moreover, sectors with high FDI potential were identified and an Investment Promotion Certification program was completed in January 2018. With the new Inland Revenue Act, the government also switched its investment incentive scheme from tax holidays, which reward profit making, to investment allowances, which incentivize investment in April 2018.
• Eliminating barriers to trade. The program aims to eliminate policy obstacles and regulatory barriers to trade. Under the program, a trade vision document to set an overall framework for trade facilitation reforms was adopted. In addition, the National Trade Facilitation Committee (NTFC) Secretariat became fully operational. The National Trade Facilitation Action Plan was also finalized.
• Fostering enterprise competitiveness. The program aims to leverage innovation and entrepreneurship for export competitiveness and enhance the competitiveness of the tourism sector. Under the program, the Tourism Vision 2025 and the Tourism Strategic Action Plan were approved by the Cabinet Committee. Subsequently the Innovation and Entrepreneurship Roadmap to develop Innovation and Entrepreneurship Strategy, Intellectual Property Rights Framework and National Quality Infrastructure Strategy were adopted by the Cabinet.
1 Based on World Bank Group (2017) and other sources.16. Moreover, the focus of the trade policy discussions is gradually shifting towards an enabling environment for investment. Despite its complex and expensive system of tax incentives to promote investment, Sri Lanka’s foreign investment has remained below 2 percent of GDP over the past twenty years. In addition, new FDI in the past few years has been predominantly infrastructure oriented with only a relatively small proportion reaching sectors that are associated with global value chains.18 With the new Inland Revenue Act, (IRA; see paragraph 19) the authorities have moved away from inefficient case-by-case customizations of tax incentives towards a more transparent, even-handed, and predictable framework. In line with this shift, the country has also launched various trade sector reforms with the help of the World Bank (box below).
Business Environment and Other Competitiveness Challenges
17. The country faces several structural and competitiveness challenges to achieve the goal of becoming a regional hub for trade and services. Beyond its trade liberalization agenda, several competitiveness obstacles remain to be addressed to jump start investment and regional integration. The rest of this section provides an overview of key competitiveness challenges and opportunities and summarizes some of the authorities’ reform initiatives in this area (text table).
Sri Lanka: Competitiveness Challenges and Opportunities
Sri Lanka: Competitiveness Challenges and Opportunities
| Challenges | Opportunities |
|---|---|
| Weak trade competitiveness | New trade agreements |
| Closed economy | Access to EU GSP |
| Regulatory favoritism | Removing para-tariffs |
| Worsening doing business ranking | New IRA with new investment incentives |
| Complex tax system | New infrastructure |
| Declining population growth | High literacy |
| Weak skills | Female labor force participation |
Sri Lanka: Competitiveness Challenges and Opportunities
| Challenges | Opportunities |
|---|---|
| Weak trade competitiveness | New trade agreements |
| Closed economy | Access to EU GSP |
| Regulatory favoritism | Removing para-tariffs |
| Worsening doing business ranking | New IRA with new investment incentives |
| Complex tax system | New infrastructure |
| Declining population growth | High literacy |
| Weak skills | Female labor force participation |
18. Structural reforms could have a significant impact on long-term growth in Sri Lanka. For Sri Lanka to reach the average level of emerging market economies over a ten-year period, the annual real GDP growth could be increased by about 0.6 percentage points per year through product market reforms and around 0.2 percentage points per year through a trade tariff reduction, based on a framework by Lusinyan (2017) (box below).19 An empirical study by Weerasinghe (2005) also finds that an increase in openness would raise Sri Lanka’s growth through both improvements in total factor productivity and accumulation of physical and human capital.
Illustrative Impact of Structural Reforms on GDP per Capita
(In percent)
Citation: IMF Staff Country Reports 2018, 176; 10.5089/9781484362358.002.A001
Source: IMF Staff Calculations.Illustrative Impact of Structural Reforms on GDP per Capita
(In percent)
Citation: IMF Staff Country Reports 2018, 176; 10.5089/9781484362358.002.A001
Source: IMF Staff Calculations.Illustrative Impact of Structural Reforms on GDP per Capita
(In percent)
Citation: IMF Staff Country Reports 2018, 176; 10.5089/9781484362358.002.A001
Source: IMF Staff Calculations.Estimation of the Impact of Structural Reforms in Emerging Market Economies
Past literature found that structural reforms could have a significant impact on long-term economic growth. Lusinyan (2017) developed a methodology to quantify the impact of structural reforms on growth (denoted z in the equation below), by separating the reforms’ impact on capital accumulation, labor utilization, and productivity/technical efficiency, using data from 32 emerging market economies and 27 advanced economies in the period between 1980 and 2016 following Égert and Gal (2016).1 The paper found that the largest impact comes through the productivity/efficiency channel. The greatest efficiency tends to be brought in by regulatory reforms in the product market. It also found that reducing trade tariffs and lowing costs of starting a business have a great impact through the capital accumulation channel.
1 Emerging market economies include Argentina, Brazil, Bulgaria, Czech Republic, Chile, China, Colombia, Estonia, Cyprus, Estonia, Hungary, India, Indonesia, Korea, Latvia, Lithuania, Malaysia, Malta, Mexico, Pakistan, Peru, Philippines, Poland, Romania, Russia, Slovak Republic, Slovenia, South Africa, Thailand, Turkey, Ukraine, Venezuela, and Vietnam.19. Sri Lanka’s IRA legal reform, approved last October 2017, is a remarkable step to modernize the tax regime and create a more predictable business environment. Sri Lanka’s complex and volatile tax system has been harming business for decades.20 Over the past four decades, tax expenditures have been used extensively to achieve a variety of goals such as promoting investment, strategic development, job creation, protecting key industries, and the socially vulnerable. Once tax incentives were granted, they were rarely repealed, leading to proliferation of tax expenditures without necessarily delivering on development goals. Recent studies even show that incentives benefit a large portion of firms which would be profitable even without incentives.21 Tax incentives were not well targeted and costly in terms of forgone revenue.22 To address these weaknesses, the new IRA decisively moves away from a complex combination of redistributive and development objectives embedded in the colonial tax laws. It also gives a clear guidance for long-term investment decisions, firmly shifting from fragmented and ambiguous decision-making around investment incentives, to transparent, unified, and even-handed legal framework.
20. Transportation networks could be further developed and access to land should be improved. After the post-war reconstruction, Sri Lanka has one of the best road and port infrastructure in the South Asian region. That said, more remains to be done in developing road and transportation networks with the North-East regions to enable better inland trade integration as well as tourism access to these regions. Access to land also remains problematic for investors. The state ownership of land is more than 80 percent23 and the process of obtaining lease and permits is excessively burdensome with a number of different legislations and parallel forms of land registration involved. The government is considering developing a consolidated land cadaster system and easing lease and permit procedures.
Infrastructure in Sri Lanka
Citation: IMF Staff Country Reports 2018, 176; 10.5089/9781484362358.002.A001
Note: Public education infrastructure is measured as secondary teachers per 1,000 persons; Electricity production per capita as kWh per 1,000 persons; Roads per capita as km per 1,000 persons; and Public health infrastructure as hospital beds per 1,000 persons. The most recent year is used for each indicator depending on the availability of data.Sources: World Economic Forum, World Bank and IMF staff Estimates.Infrastructure in Sri Lanka
Citation: IMF Staff Country Reports 2018, 176; 10.5089/9781484362358.002.A001
Note: Public education infrastructure is measured as secondary teachers per 1,000 persons; Electricity production per capita as kWh per 1,000 persons; Roads per capita as km per 1,000 persons; and Public health infrastructure as hospital beds per 1,000 persons. The most recent year is used for each indicator depending on the availability of data.Sources: World Economic Forum, World Bank and IMF staff Estimates.Infrastructure in Sri Lanka
Citation: IMF Staff Country Reports 2018, 176; 10.5089/9781484362358.002.A001
Note: Public education infrastructure is measured as secondary teachers per 1,000 persons; Electricity production per capita as kWh per 1,000 persons; Roads per capita as km per 1,000 persons; and Public health infrastructure as hospital beds per 1,000 persons. The most recent year is used for each indicator depending on the availability of data.Sources: World Economic Forum, World Bank and IMF staff Estimates.21. The quality of education can be further strengthened. Sri Lanka has a remarkable 93 percent literacy rate, widespread access to education, high completion rates in both primary and secondary education, and gender parity in general education. However, the quality of general education lags other upper middle-income countries.24 Although access to primary and secondary education is impressive, achievement is modest with only one third of primary school children mastering language and mathematics skills. Moreover, while the proportion of Sri Lankans with secondary education are comparable to that of East Asian countries, Sri Lanka’s tertiary education numbers are much lower than in East Asian countries.
22. Despite high access to education, the overall skills of the workforce need to be upgraded. In the WEF Global Competitiveness Index, restrictive labor regulations (4th most problematic) and poor work ethics (2nd most problematic), inadequately educated workforce, and insufficient capacity to innovate were quoted among the top problematic factors for business.25 There is a need to build up quality of primary and secondary education, expand supply of vocational training and technical skills, and introduce soft skills in the general education. For example, only 28 percent of workers can use computers and only 20 percent are proficient in English, with lower ratios in rural regions when over 75 per cent of employers expect a high-skill worker have English language and computer skills.26 Employers are also demanding soft skills such as teamwork, presentation, and decision making which are not fully incorporated in education and training systems.
23. Sri Lanka’s low unemployment rate masks segmentation in the labor market and an increasing dependency ratio. Sri Lanka’s demographic dividend is quickly narrowing, unlike in other South Asian economies, as working age population is expected to grow slowly (13–14 percent rate) and then gradually decline, raising over time the number of elderly people that need to be supported by active workers. Low unemployment rates (4 percent) mask several problems such as high youth unemployment (22 percent), low female labor force participation rate (36 percent)27 and skilled labor shortages in manufacturing and construction. An estimated two-third of workers are employed informally. Policies to better enable youth employment and female labor force participation may help to address the aging population challenge in the context of large development needs.
C. Conclusions
24. The government has ambitious plans to achieve upper middle-income country status in 2025 by transforming Sri Lanka in an Indian Ocean Hub for trade, investment, and services. Unlike the 70–80s when investment in the tradable sectors led the productivity boost, the post-war capital deepening was mainly driven by mega-scale public-financed infrastructure projects, which did not seem to result in immediate productivity gains, as reforms to enable the business environment lagged. Sri Lanka’s static export structure signifies an absence of competitive forces to drive trade dynamism, innovation, and diversification: for over two decades exports have remained concentrated on garments, tea, and rubber products with a declining share in global trade. Introduction of para-tariffs barriers during the last decade has effectively doubled the protection rate, making the present trade regime one of the most complex and protectionist in the world. Despite operating a complex and an expensive system of tax incentives to promote investment, FDI remains low.
25. Stable and transparent regulatory systems would make Sri Lanka’s business environment more attractive for long-term investment and support trade integration. Breaking from the past, Sri Lanka’s new IRA, approved in October 2017, decisively moves to a transparent, unified, and even-handed legal framework, from the previous ad hoc, fragmented, and ambiguous tax investment incentives. Consistent implementation of this new rule-based system could help unlock long-term investment decisions. A simplification of tax systems, including trade tariffs and para-tariffs, through predictable, fair, and automated mechanisms, can remove uncertainties that hold back trade and investment decisions and support the needed shift towards more private sector-led growth. Reviewing trade barriers and developing a phased and sequenced strategy for gradual removal of restrictions is a first necessary step towards enabling more competitive trade. In this regard, the authorities’ decision to gradually rationalize para-tariffs and set up automated approval systems is a welcome step. Ongoing open consultative processes on reform strategies can also help building public consensus in support of these important objectives.
Annex I. TFP Accounting and Data Sources
This section summarizes the three methods of aggregate TFP accounting presented in the paper as well as the data sources for the estimations and sensitivity analysis.
Methodologies
Solow Residual TFP
Human Capital Adjusted TFP
Capital and Labor Utilization Adjusted TFP
Differentiating the production function and dropping time subscripts yields:
Where output Yt is a function of At (TFP), the stock of physical capital Kt and zt is the capital utilization. Human Capital adjustment is denoted by ht and utilization adjusted labor, which is the product of a labor utilization Ut times persons engaged given by Lt. α is the output elasticity of physical capital, and 1 - α is the output elasticity of augmented labor.
We use Bosworth and Collins (2006)’s approach to show reallocation effects in the growth accounts. Sectoral decomposition is applied to aggregate labor productivity growth to separate the sectoral reallocation effects, the first term on the right-hand side, from the sectoral composition effect, the second term. Employment shares are denoted by s and value-added shares by sy, sectors are denoted by j.
Data Definition and Sources
The accuracy of the growth accounting exercise depends on the correctness of the methodologies, as well as the measurement of factor inputs and factor shares. Studies show that differences in methodology and data sets have produced significantly different estimates of TFP growth rates (Weerasinghe 2005). Therefore, while this study uses widely accepted methodologies and assumptions which have reached consensus in the literature, it is also important to note the limitations that arise from inconsistencies and quality of data.
| Output | Gross domestic production, real growth rates and sectoral contribution were obtained from the Special Appendix Table of Annual Report 2016 and Economic Social Statistics 2017 by Central Bank of Sri Lanka (CBSL). GDP deflator (2010=100) was taken from World Development Indicators. The sectoral real growth rate is calculated as the year-on-year change in gross domestic production/gross value added in constant prices with different base years and those growth rates are used to extrapolate sectoral and aggregate real GDP in 2010 prices. The National Account estimates were revised in 1970, 1982, and 1996 by the Central Bank of Sri Lanka and Department of Census and Statistics in 2002 and 2010. Due to such rebasing exercises, a consistent long series of real output was not readily available and therefore, was estimated using the real growth rates of different base years in 2010 prices (see also sensitivity analysis below). |
| Capital | Gross fixed capital formation in constant local currency, inventories in constant local currency and adjusted savings: consumption of fixed capital (% of GNI) obtained from World Development Indicators. Capital stock was estimated under the perpetual inventory method with 7 percent depreciation rate using gross fixed capital formation and changes in inventories. |
| Labor | Number of persons engaged, share of labor compensation in GDP and annual average hours worked were taken from Penn World Tables. Sectoral labor shares as a percent of total employment was taken from labor force surveys (1990 onwards) and similar surveys (before 1990) of Department of Census and Statistics obtained from CBSL Annual Report 2000 (Special Statistical Appendix – Table 4). The missing values in between the periods are imputed using fixed growth assumption. |
| The labor information for Sri Lanka comes from many sources. The labor data prior to 1990 comes from Census of Population, Socio Economic Survey and Land and Labor Utilization Survey that have been conducted at irregular intervals. The primary source of the labor force and employment, Labor Force Survey conducted by the Department of Census and Statistics (DCS) only since 1990. However, due to the ongoing conflict in the country, two provinces were inaccessible to conduct the survey regularly. Such inclusions and exclusions and different coverages of the surveys shows up in the national data as anomalies. Therefore, the persons engaged information from the Penn World tables were considered in place of it. | |
| Utilization Rates | CBSL publishes capacity utilization series in annual reports based on factory industrial production surveys on output and usage of installed capacity. Capacity utilization rates for 1968–1975 are taken from CBSL Annual Report 2000, Special Appendix Table 14 and were extracted from “The Economy of Sri Lanka”. Labor utilization rates are estimated using the average annual hours worked by the persons engaged available in the Penn World Tables (PWT) until 2014 and CBSL’s new series on gross value added per hour worked since 2014. The maximum workable hours in a week is assumed to be 40. |
| Labor and Capital Share of Income | In using Cobb-Douglas production function to conduct growth accounting exercise, constant returns to scale are assumed. In the growth accounting literature, the capital share of income varies between 0.3–0.4 for emerging market countries. However, for this study, the labor share of income was taken as 0.7, a 15-year average based on the data available in Penn World Table on labor share of income for Sri Lanka. Therefore, the capital share is 0.3. The following sub-section presents the results of sensitivity analysis carried out for various depreciation rates, capital share of income and human capital adjustment. |
| Human Capital Index and Literacy Rate | Human Capital Index for Sri Lanka published by the Penn World Table 9.0 is based on the average years of schooling from Barro and Lee (BL, 2013) and an assumed rate of return to education, based on Mincer equation estimates around the world (Psacharopoulos, 1994). The free education policy was implemented in the late 1945. In 1911, the literacy rate of Sri Lanka was 31% and in 1971 it was improved to 78.1%. Therefore, high rates of human capital development during the early 1970s are in line with the policies prevailed. |
| Agriculture | FAO Agriculture Capital Stock (ACS) database publishes country-by-country data on physical investment in agriculture, forestry and fishing as measured by the System of National Accounts (SNA) concept of Gross Fixed Capital Formation (GFCF) since 1990. For this study, the GFCF in current local currency for agriculture deflated by deflator (2010=100) was taken without any adjustments. Then the perpetual inventory method with 7 percent depreciation was employed to estimate the capital stock. The depreciation rate is in line with consumption of fixed capital as a per cent of agriculture value added available in the FAO database. Bosworth and Collins (2007) add land as an input for agriculture growth accounting. However, following their observation that addition of land does not make a substantial difference to results, we omit land from our study. |
| Industry, Manufacturing | Employment and gross additions to fixed capital formation for manufacturing and industries (without construction activities) were taken from the Annual Survey of Industries by Department of Census and Statistics. The missing values and 2015–16 values for gross fixed capital formation were calculated using the total capital stock growth rate. |
| Effective Rate of Protection | Effective rates of protection are derived from Input – Output Tables published by Department of Census and Statistics. The Department of Census and Statistics calculated nominal and effective rates of protection for 127 industries using nominal tariff rates, input shares of industries from Supply-Use Table and Symmetric Input Output Table (SIOT) framework of Sri Lanka for 2010 and 2015. Unlike the traditional approach to calculate ERP, the I/O tale approach is complete and consistent, as it covers all the inputs, outputs and accounts for the usage of tradables. tt- nominal tariff on i and aij – the share of final value of j accounted for by input i. |
| Output | Gross domestic production, real growth rates and sectoral contribution were obtained from the Special Appendix Table of Annual Report 2016 and Economic Social Statistics 2017 by Central Bank of Sri Lanka (CBSL). GDP deflator (2010=100) was taken from World Development Indicators. The sectoral real growth rate is calculated as the year-on-year change in gross domestic production/gross value added in constant prices with different base years and those growth rates are used to extrapolate sectoral and aggregate real GDP in 2010 prices. The National Account estimates were revised in 1970, 1982, and 1996 by the Central Bank of Sri Lanka and Department of Census and Statistics in 2002 and 2010. Due to such rebasing exercises, a consistent long series of real output was not readily available and therefore, was estimated using the real growth rates of different base years in 2010 prices (see also sensitivity analysis below). |
| Capital | Gross fixed capital formation in constant local currency, inventories in constant local currency and adjusted savings: consumption of fixed capital (% of GNI) obtained from World Development Indicators. Capital stock was estimated under the perpetual inventory method with 7 percent depreciation rate using gross fixed capital formation and changes in inventories. |
| Labor | Number of persons engaged, share of labor compensation in GDP and annual average hours worked were taken from Penn World Tables. Sectoral labor shares as a percent of total employment was taken from labor force surveys (1990 onwards) and similar surveys (before 1990) of Department of Census and Statistics obtained from CBSL Annual Report 2000 (Special Statistical Appendix – Table 4). The missing values in between the periods are imputed using fixed growth assumption. |
| The labor information for Sri Lanka comes from many sources. The labor data prior to 1990 comes from Census of Population, Socio Economic Survey and Land and Labor Utilization Survey that have been conducted at irregular intervals. The primary source of the labor force and employment, Labor Force Survey conducted by the Department of Census and Statistics (DCS) only since 1990. However, due to the ongoing conflict in the country, two provinces were inaccessible to conduct the survey regularly. Such inclusions and exclusions and different coverages of the surveys shows up in the national data as anomalies. Therefore, the persons engaged information from the Penn World tables were considered in place of it. | |
| Utilization Rates | CBSL publishes capacity utilization series in annual reports based on factory industrial production surveys on output and usage of installed capacity. Capacity utilization rates for 1968–1975 are taken from CBSL Annual Report 2000, Special Appendix Table 14 and were extracted from “The Economy of Sri Lanka”. Labor utilization rates are estimated using the average annual hours worked by the persons engaged available in the Penn World Tables (PWT) until 2014 and CBSL’s new series on gross value added per hour worked since 2014. The maximum workable hours in a week is assumed to be 40. |
| Labor and Capital Share of Income | In using Cobb-Douglas production function to conduct growth accounting exercise, constant returns to scale are assumed. In the growth accounting literature, the capital share of income varies between 0.3–0.4 for emerging market countries. However, for this study, the labor share of income was taken as 0.7, a 15-year average based on the data available in Penn World Table on labor share of income for Sri Lanka. Therefore, the capital share is 0.3. The following sub-section presents the results of sensitivity analysis carried out for various depreciation rates, capital share of income and human capital adjustment. |
| Human Capital Index and Literacy Rate | Human Capital Index for Sri Lanka published by the Penn World Table 9.0 is based on the average years of schooling from Barro and Lee (BL, 2013) and an assumed rate of return to education, based on Mincer equation estimates around the world (Psacharopoulos, 1994). The free education policy was implemented in the late 1945. In 1911, the literacy rate of Sri Lanka was 31% and in 1971 it was improved to 78.1%. Therefore, high rates of human capital development during the early 1970s are in line with the policies prevailed. |
| Agriculture | FAO Agriculture Capital Stock (ACS) database publishes country-by-country data on physical investment in agriculture, forestry and fishing as measured by the System of National Accounts (SNA) concept of Gross Fixed Capital Formation (GFCF) since 1990. For this study, the GFCF in current local currency for agriculture deflated by deflator (2010=100) was taken without any adjustments. Then the perpetual inventory method with 7 percent depreciation was employed to estimate the capital stock. The depreciation rate is in line with consumption of fixed capital as a per cent of agriculture value added available in the FAO database. Bosworth and Collins (2007) add land as an input for agriculture growth accounting. However, following their observation that addition of land does not make a substantial difference to results, we omit land from our study. |
| Industry, Manufacturing | Employment and gross additions to fixed capital formation for manufacturing and industries (without construction activities) were taken from the Annual Survey of Industries by Department of Census and Statistics. The missing values and 2015–16 values for gross fixed capital formation were calculated using the total capital stock growth rate. |
| Effective Rate of Protection | Effective rates of protection are derived from Input – Output Tables published by Department of Census and Statistics. The Department of Census and Statistics calculated nominal and effective rates of protection for 127 industries using nominal tariff rates, input shares of industries from Supply-Use Table and Symmetric Input Output Table (SIOT) framework of Sri Lanka for 2010 and 2015. Unlike the traditional approach to calculate ERP, the I/O tale approach is complete and consistent, as it covers all the inputs, outputs and accounts for the usage of tradables. tt- nominal tariff on i and aij – the share of final value of j accounted for by input i. |
Sri Lanka. Utilization of Capital and Labor
(Period Averages)
Sri Lanka. Utilization of Capital and Labor
(Period Averages)
| Labor | Capital | Capital/Labor | |
|---|---|---|---|
| 1971–77 | 0.83 | 0.63 | −0.21 |
| 1978–87 | 0.95 | 0.75 | −0.21 |
| 1988–02 | 0.95 | 0.82 | −0.12 |
| 2003–09 | 0.97 | 0.83 | −0.14 |
| 2010–16 | 0.97 | 0.79 | −0.18 |
Sri Lanka. Utilization of Capital and Labor
(Period Averages)
| Labor | Capital | Capital/Labor | |
|---|---|---|---|
| 1971–77 | 0.83 | 0.63 | −0.21 |
| 1978–87 | 0.95 | 0.75 | −0.21 |
| 1988–02 | 0.95 | 0.82 | −0.12 |
| 2003–09 | 0.97 | 0.83 | −0.14 |
| 2010–16 | 0.97 | 0.79 | −0.18 |
Sri Lanka. Human Capital Index (Average growth rates)
Sri Lanka. Human Capital Index (Average growth rates)
| Human Capital Index | |
|---|---|
| 1961–70 | 3.6 |
| 1971–77 | 1.7 |
| 1978–87 | 3.0 |
| 1988–02 | 3.3 |
| 2003–09 | 0.1 |
| 2010–16 | −0.2 |
Sri Lanka. Human Capital Index (Average growth rates)
| Human Capital Index | |
|---|---|
| 1961–70 | 3.6 |
| 1971–77 | 1.7 |
| 1978–87 | 3.0 |
| 1988–02 | 3.3 |
| 2003–09 | 0.1 |
| 2010–16 | −0.2 |
Sensitivity Analysis
In the calculations below using the 2002 base year growth rates for the period 2010–2015, TFP growth rates increase by 0.4–0.5 percent range for different methodologies.
Sri Lanka: Sources of Growth – Sensitivity Analysis
(Average growth rate, in percent)
Sri Lanka: Sources of Growth – Sensitivity Analysis
(Average growth rate, in percent)
| Output | Employment | Capital | Contribution of: | ||
|---|---|---|---|---|---|
| Factor Productivity | |||||
| Solow Residual with Human Capital (HC) Adjustment | |||||
| 1961–70 | 4.7 | 4.3 | 2.8 | −2.5 | |
| 1971–77 | 2.9 | 2.4 | 2.7 | −2.2 | |
| 1978–87 | 5.4 | 4.2 | 3.3 | −2.1 | |
| 1988–02 | 4.6 | 3.1 | 1.4 | 0.1 | |
| 2003–09 | 6.0 | 1.2 | 1.6 | 3.1 | |
| 2010–16 | 6.3 | 0.6 | 2.3 | 3.3 | |
| Capacity Utilization and HC Adjustment | |||||
| 1971–77 | 2.9 | 2.4 | 2.3 | −1.8 | |
| 1978–87 | 5.4 | 4.2 | 4.3 | −3.0 | |
| 1988–02 | 4.6 | 3.1 | 1.4 | 0.1 | |
| 2003–09 | 6.0 | 1.2 | 0.5 | 4.2 | |
| 2010–16 | 6.3 | 0.6 | 3.6 | 2.0 | |
| Capacity and Labor Utilization and HC Adjustment | |||||
| 1971–77 | 2.9 | 4.8 | 2.3 | −4.2 | |
| 1978–87 | 5.4 | 4.1 | 4.3 | −3.0 | |
| 1988–02 | 4.6 | 3.1 | 1.4 | 0.1 | |
| 2003–09 | 6.0 | 1.4 | 0.5 | 4.0 | |
| 2010–16 | 6.3 | 0.5 | 3.6 | 2.2 | |
| Solow Residual: Depreciation 5% and Capital share 0.3 | |||||
| 1961–70 | 4.7 | 1.8 | 2.7 | 0.2 | |
| 1971–77 | 2.9 | 1.2 | 2.6 | −0.9 | |
| 1978–87 | 5.4 | 2.0 | 3.2 | 0.1 | |
| 1988–02 | 4.6 | 0.8 | 1.4 | 2.4 | |
| 2003–09 | 6.0 | 1.1 | 1.6 | 3.2 | |
| 2010–16 | 6.3 | 0.8 | 2.3 | 3.2 | |
| Utilization Adjusted: Depreciation 5% and Capital share 0.3 | |||||
| 1971–77 | 2.9 | 3.7 | 2.2 | −3.0 | |
| 1978–87 | 5.4 | 2.0 | 4.2 | −0.8 | |
| 1988–02 | 4.6 | 0.7 | 1.5 | 2.4 | |
| 2003–09 | 6.0 | 1.3 | 0.5 | 4.1 | |
| 2010–16 | 6.3 | 0.6 | 3.6 | 2.1 | |
| Solow Residual: Depreciation 7% and Capital share 0.4 | |||||
| 1961–70 | 4.7 | 1.5 | 3.8 | −0.6 | |
| 1971–77 | 2.9 | 1.0 | 3.6 | −1.7 | |
| 1978–87 | 5.4 | 1.7 | 4.4 | −0.7 | |
| 1988–02 | 4.6 | 0.7 | 1.8 | 2.1 | |
| 2003–09 | 6.0 | 1.0 | 2.1 | 2.8 | |
| 2010–16 | 6.3 | 0.7 | 3.1 | 2.5 | |
| Utilization Adjusted: Depreciation 7% and Capital share 0.4 | |||||
| 1971–77 | 2.9 | 3.1 | 3.1 | −3.3 | |
| 1978–87 | 5.4 | 1.7 | 5.7 | −2.0 | |
| 1988–02 | 4.6 | 0.6 | 1.9 | 2.1 | |
| 2003–09 | 6.0 | 1.1 | 0.7 | 4.1 | |
| 2010–16 | 6.3 | 0.5 | 4.8 | 1.0 | |
Sri Lanka: Sources of Growth – Sensitivity Analysis
(Average growth rate, in percent)
| Output | Employment | Capital | Contribution of: | ||
|---|---|---|---|---|---|
| Factor Productivity | |||||
| Solow Residual with Human Capital (HC) Adjustment | |||||
| 1961–70 | 4.7 | 4.3 | 2.8 | −2.5 | |
| 1971–77 | 2.9 | 2.4 | 2.7 | −2.2 | |
| 1978–87 | 5.4 | 4.2 | 3.3 | −2.1 | |
| 1988–02 | 4.6 | 3.1 | 1.4 | 0.1 | |
| 2003–09 | 6.0 | 1.2 | 1.6 | 3.1 | |
| 2010–16 | 6.3 | 0.6 | 2.3 | 3.3 | |
| Capacity Utilization and HC Adjustment | |||||
| 1971–77 | 2.9 | 2.4 | 2.3 | −1.8 | |
| 1978–87 | 5.4 | 4.2 | 4.3 | −3.0 | |
| 1988–02 | 4.6 | 3.1 | 1.4 | 0.1 | |
| 2003–09 | 6.0 | 1.2 | 0.5 | 4.2 | |
| 2010–16 | 6.3 | 0.6 | 3.6 | 2.0 | |
| Capacity and Labor Utilization and HC Adjustment | |||||
| 1971–77 | 2.9 | 4.8 | 2.3 | −4.2 | |
| 1978–87 | 5.4 | 4.1 | 4.3 | −3.0 | |
| 1988–02 | 4.6 | 3.1 | 1.4 | 0.1 | |
| 2003–09 | 6.0 | 1.4 | 0.5 | 4.0 | |
| 2010–16 | 6.3 | 0.5 | 3.6 | 2.2 | |
| Solow Residual: Depreciation 5% and Capital share 0.3 | |||||
| 1961–70 | 4.7 | 1.8 | 2.7 | 0.2 | |
| 1971–77 | 2.9 | 1.2 | 2.6 | −0.9 | |
| 1978–87 | 5.4 | 2.0 | 3.2 | 0.1 | |
| 1988–02 | 4.6 | 0.8 | 1.4 | 2.4 | |
| 2003–09 | 6.0 | 1.1 | 1.6 | 3.2 | |
| 2010–16 | 6.3 | 0.8 | 2.3 | 3.2 | |
| Utilization Adjusted: Depreciation 5% and Capital share 0.3 | |||||
| 1971–77 | 2.9 | 3.7 | 2.2 | −3.0 | |
| 1978–87 | 5.4 | 2.0 | 4.2 | −0.8 | |
| 1988–02 | 4.6 | 0.7 | 1.5 | 2.4 | |
| 2003–09 | 6.0 | 1.3 | 0.5 | 4.1 | |
| 2010–16 | 6.3 | 0.6 | 3.6 | 2.1 | |
| Solow Residual: Depreciation 7% and Capital share 0.4 | |||||
| 1961–70 | 4.7 | 1.5 | 3.8 | −0.6 | |
| 1971–77 | 2.9 | 1.0 | 3.6 | −1.7 | |
| 1978–87 | 5.4 | 1.7 | 4.4 | −0.7 | |
| 1988–02 | 4.6 | 0.7 | 1.8 | 2.1 | |
| 2003–09 | 6.0 | 1.0 | 2.1 | 2.8 | |
| 2010–16 | 6.3 | 0.7 | 3.1 | 2.5 | |
| Utilization Adjusted: Depreciation 7% and Capital share 0.4 | |||||
| 1971–77 | 2.9 | 3.1 | 3.1 | −3.3 | |
| 1978–87 | 5.4 | 1.7 | 5.7 | −2.0 | |
| 1988–02 | 4.6 | 0.6 | 1.9 | 2.1 | |
| 2003–09 | 6.0 | 1.1 | 0.7 | 4.1 | |
| 2010–16 | 6.3 | 0.5 | 4.8 | 1.0 | |
Annex II. Export Structure
Sri Lanka and Vietnam had a relatively similar export composition in 1995, mainly concentrated in agriculture good and textiles. Vietnam was able to diversify exports towards light electronics and manufacturing, while Sri Lanka’s export structure remained mostly unchanged in past two decades.
Sri Lanka: Export Structure
Citation: IMF Staff Country Reports 2018, 176; 10.5089/9781484362358.002.A001
Source: http://atlas.cid.harvard.edu/Sri Lanka: Export Structure
Citation: IMF Staff Country Reports 2018, 176; 10.5089/9781484362358.002.A001
Source: http://atlas.cid.harvard.edu/Sri Lanka: Export Structure
Citation: IMF Staff Country Reports 2018, 176; 10.5089/9781484362358.002.A001
Source: http://atlas.cid.harvard.edu/
Vietnam: Export Structure
Citation: IMF Staff Country Reports 2018, 176; 10.5089/9781484362358.002.A001
Source: http://atlas.cid.harvard.edu/Vietnam: Export Structure
Citation: IMF Staff Country Reports 2018, 176; 10.5089/9781484362358.002.A001
Source: http://atlas.cid.harvard.edu/Vietnam: Export Structure
Citation: IMF Staff Country Reports 2018, 176; 10.5089/9781484362358.002.A001
Source: http://atlas.cid.harvard.edu/References
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Prepared by Eteri Kvintradze, Amitha Sundararaj, and Misa Takebe.
See Annex I for different methods of growth accounting, description of data sources, utilization rates, and sensitivity analysis.
Blanchard and Kremer (1997) predict that disorganization releases production inputs which are reallocated to other sectors less susceptible to disorganization. The process of reallocation is gradual and disorganization ends once old relationships are reorganized. Empirical studies of disorganization use utilization adjustment to better capture factor contributions and reallocation effects on growth. Utilization adjusted TFP residual could be lower or higher than a simple Solow residual depending on the downward or upward trends in utilization rates. For example, higher capacity utilization rates will result in increased capital contribution to growth compared to lower utilization rates.
See IMF Country Report No. 17/253, Box 2 (https://www.imf.org/en/Publications/CR/Issues/2017/08/10/Sri-Lanka-Second-Review-under-the-Extended-Arrangement-under-the-Extended-Fund-Facility-45178).
FDI new inflows dropped to 1.1 percent of GDP in 2016, compared, for example, to 6.1 percent of GDP in Vietnam for the same period (WDI).
April 2015 World Economic Outlook, Chapter 3 (http://www.imf.org/external/pubs/ft/weo/2015/01/).
The largest manufacturing subsectors are food and beverages, textiles, rubber, and chemicals.
This section uses five perception-based indicators (Doing Business Indicators by the World Bank, Global Competitiveness Index and Perceived Infrastructure Quality Index by the World Economic Forum, International Trade Center series on non-tariff measures, and Worldwide Governance Indicators by the Brookings Institution and the World Bank). The accuracy of the indicators can be biased by experts’ views. These non-IMF indicators provide qualitative information but do not represent the IMF’s assessment.
The indicators are designed to help assessing three key trade policy areas (trade in goods, trade in services, and FDI) by marking 0 to the country with the most restrictive value and 1 to the country with the least restrictive value among 96 countries. For more details, please see Cerdeiro and Nam (2018).
Trade facilitation performance is the average of 11 dimensions of the World Trade Organization’s Trade Facilitation Agreement (such as information availability, appeal procedures, fees and charges, and documentation formalities). The MFN tariff in the indicators does not cover para tariffs, which play an important role in Sri Lanka.
Para-tariffs are non-tariff barriers to trade and include the Ports and Airports Development Levy (PAL), the Commodity Export Subsidy Scheme (CESS), and the Special Commodity Levy (SCL). The Export Development Board (EDB) Levy, which was another type of para-tariffs, was eliminated 2012.
The increase in para-tariffs was not only to protect domestic industries but also to support the declining revenue base.
A survey was conducted by International Trade Center covering over 500 businesses on their views regarding non- tariff measures. The results can be accessed through http://www.intracen.org/publications/ntm/SriLanka/.
The Effective Rate of Protection (ERP) is calculated by Department of Census and Statistics and is defined as the difference between value added (per unit of output) in domestic prices and value added in world prices, expressed as a percentage of the latter. See Annex I.
Protection is granted by tariff, non-tariff, and/or tax exemptions.
On average, manufacturing sector received 22–25 percent of total FDIs during the period 2014–2017.
Among the structural variables used by Lusinyan (2017), Sri Lanka has lost its competitiveness especially in terms of product market regulations and trade tariffs over the last decade. Product market regulations are gauged by the Regulatory Quality index of the World Governance Indicators, which measures perceptions of the ability of the government to formulate and implement sound policies and regulations that permit and promote private sector development. Trade tariffs are gauged by the World Economic Forum, which is a trade-weighted average applied tariff rate, including para-tariffs.
Presidential Taxation Commission Report 2010, extracted from Waidyasekera (2016).
More than one percentage point of GDP, two third of actual revenue collected, is lost to Corporate Income Tax incentives annually.
World Bank (2015a), Page 74.
World Bank (2015a), Page 5.
The ranking of these factors is based on World Economic Forum’s Executive Opinion Survey with a sample size of 75–100 for Sri Lanka on their ranking of the five most problematic factors for doing business in the country, with a rank between 1 (most problematic) and 5 (http://reports.weforum.org/global-competitiveness-index-2017-2018/).
World Bank (2015a), Page 14.
Annual labor force survey 2016, Department of Census and Statistics.
